My name is Mark Goodfield. Welcome to The Blunt Bean Counter ™, a blog that shares my thoughts on income taxes, finance and the psychology of money. I am a Chartered Professional Accountant and a partner with a National Accounting Firm in Toronto. This blog is meant for everyone, but in particular for high net worth individuals and owners of private corporations. The views and opinions expressed in this blog are written solely in my personal capacity and cannot be attributed to the accounting firm with which I am affiliated. My posts are blunt, opinionated and even have a twist of humor/sarcasm. You've been warned.

Wednesday, April 22, 2015

2015 Federal Budget

The Federal Minister of Finance, Joe Oliver, yesterday presented the 2015 Federal Budget. It is a good thing Joe was giving away tax goodies, because announcing a budget with 9 days left in income tax season does not make many accountant friends :)

There was much to like in this budget. The proposed increase in the Tax-Free Savings Account ("TFSA") limit, the proposed reduction in the minimum withdrawal for Registered Retirement Income Funds ("RRIF") and the proposed reductions in small business tax rates. It will be interesting to see if these changes ever get to see the light of day.

As I am in the home stretch of tax season, I don't have the time for a detailed analysis of the budget, so I will just offer some brief comments.

TFSAs


As rumoured, the contribution limit for TFSAs will be increased from $5,500 to $10,000 per year effective January 1, 2015. However, the new limit will not be indexed. This proposed change has the potential to drastically alter the way Canadians save and plan for retirement. On Monday, since everyone has already told you how great this is, I will discuss the downside to this change.

RRIFs


The government proposes to lower the annual required withdrawal from your RRIF. Currently at age 71 the required withdrawal rate is 7.38%. The budget proposes to lower that rate to 5.28% as of January 1, 2015. Withdrawal rates will still increase every year, but instead of topping out at 20% at age 94, that cap is reached at age 95. RRIF holders who at any time in 2015 withdrew/withdraw more than the reduced 2015 minimum amount will be permitted to re-contribute the excess.

This change appeases seniors who felt they were being forced to draw more money than they required to live and takes into account the longer life expectancy of Canadians.

The Matching Penalty


Readers of this blog will know that one of my major pet peeves is the excessive 20% penalty for unreported income (that is often inadvertent or the result of lost slips in the mail) that is picked up each year by the CRA's matching program.

The penalty currently can be levied even if you owe no income tax. I.e.: If someone in Ontario fails to report a T4 slip with $10,000 of employment income and the slip has reported $4,900 of income tax deducted, they would owe no income tax, at the maximum marginal income tax rate. However, if you had failed to report income in any of the three prior years, the penalty under subsection 163(1) would be $2,000 (20% x $10,000), even though you owed no income tax and the CRA was provided this information by your employer.

The government will amend this penalty to prevent situations such as the above where there is a disproportionate penalty to the actual income tax. The budget proposes that the penalty will now only apply if a you fail to report at least $500 in income and more importantly; the penalty will now be equal to the lesser of 10% (penalty is 20%, as there is also a 10% provincial penalty) of the unreported income and 50% of the tax unpaid. Thus, in the example above, there would not be any penalty under the proposed legislation, as no tax would be owing.

T1135 Foreign Reporting Form


The government proposes to simplify the reporting requirements where the cost of a taxpayer's foreign property is less than $250,000. While this change is welcome, it falls short. Most accountants and taxpayers were hoping the form would only require reporting of foreign income earned outside of Canada and would exclude the detailed reporting required for accounts held with Canadian institutions.

Small Business Tax Cut


It is proposed the 11% Federal small business tax rate on active income for qualifying Canadian Controlled Private Corporations will be reduced by .5% annually beginning January 1, 2016 and will drop to 9% by January 1, 2019. The dividend gross-up and credit will be adjusted each year to reflect the lower corporate tax rate.

This site provides general information on various tax issues and other matters. The information is not intended to constitute professional advice and may not be appropriate for a specific individual or fact situation. It is written by the author solely in their personal capacity and cannot be attributed to the accounting firm with which they are affiliated. It is not intended to constitute professional advice, and neither the author nor the firm with which the author is associated shall accept any liability in respect of any reliance on the information contained herein. Readers should always consult with their professional advisors in respect of their particular situation.

Monday, April 20, 2015

Transfer Pricing - Common Issues & New Documentation Requirements

One of the most nefarious concepts in corporate taxation is transfer pricing. Today I have a guest post by Dan McGeown, an expert on transfer pricing discussing new Organisation for Economic Cooperation and Development  ("OECD") documentation guidelines that Canadian companies are expected to follow.

What is Transfer Pricing?


Before we get to Dan’s post, a quick primer on transfer pricing. Transfer prices are the prices charged between related parties for goods, services, assets and/or the right to use intangibles. Transfer prices also include interest on related party debt, guarantee fees and factoring fees. When a transaction involves related parties in two or more different tax jurisdictions, the tax authorities become interested, with the focus being on whether the parties are paying their fair share of tax in each jurisdiction (there are often huge disagreements between countries as they fight over what they consider their share of tax dollars being shifted to another country).

Simply put, transfer pricing revolves around the the setting of the price for goods and services sold between controlled (or related) companies. For example, if a subsidiary company sells goods to a parent company, the cost of those goods is the transfer price.

As a result, transfer prices must be set following the arm’s length principle. The arm’s length principle requires that all transfer prices, and the related terms and conditions, must be established on the same basis as would occur if the parties were not related, i.e., the prices, terms and conditions should reflect what two unrelated parties would agree to in similar circumstances.

Penalties and Traps


In Canada, failing to follow the arm’s length principle exposes the Canadian entity to a 10% penalty on any transfer pricing adjustment made by the CRA. The CRA may not impose that 10% penalty when the entity has made reasonable efforts to determine and use arm’s length prices, as evidenced by preparing and maintaining Contemporaneous Transfer Pricing Documentation.

Dan advises me that some of the common issues that most often trip up Canadian companies include the following:

1. Either no analysis/documentation to support a conclusion that transfer prices are arm’s length, or self-serving analysis/documentation for transfer prices not considered arm’s length;

2. Operating losses incurred in one or more years, with no documented loss justification based on business and/or economic reasons;

3. Fluctuating operating results that are not sufficiently analyzed and documented;

4. Inappropriate cost allocations used in the determination of management services fees, i.e. costs included that would not benefit the recipient of the services; and,

5. Royalty payments being made but lower than acceptable operating results do not justify charging a royalty.

A company’s Transfer Pricing Documentation is its first line of defense in any transfer pricing audit and, therefore, it needs to be prepared from that perspective.

Speaking of documentation, Dan’s post provides an update on changing expectations in respect of transfer pricing and he briefs us on some specific Canadian requirements. I thank Dan for his blog on this controversial income tax issue.

TRANSFER PRICING DOCUMENTATION: CHANGING EXPECTATIONS

By Dan McGeown

ERODING TAX BASES


The prolonged recession, and the difficulties many countries were and are still having in balancing budgets and managing debt loads, caused them to focus on the perception that each country’s tax base was being eroded by companies entering into activities that created tax deductions in higher tax jurisdictions with the offsetting income being reported in low tax or no tax jurisdictions, i.e., Base Erosion. In addition, many companies were moving valuable intangibles and/or value-adding activities to low tax or no tax jurisdictions to reduce the company’s overall effective tax rate, i.e., Profit Shifting strategies.

As result of this base erosion, the Organisation for Economic Cooperation and Development (“OECD”) is now calling for three distinct levels of documentation, being: a Master File; Local Country Files; and Country-by-Country Reporting (“CBCR”). For Canadian companies both the Master File and CBCR are new requirements.

Master File


The Master File will provide: a high-level overview of the group of companies; the value chain and value drivers; a description of intangibles and where they are located; financial arrangements; where functions are performed, risks are borne and assets are employed; and the consolidated financial and tax position for the group.

Local File


The Local File for a Canadian company is the Study prepared to comply with section 247 of the Income Tax Act, focusing on the specifics relating to intercompany transactions with other companies in the group. The Base Erosion and Profit Shifting (“BEPS”) impact on Local Files is that there must be more detailed analysis and documentation regarding risks, intangibles, financing and capital transactions, and high risk transactions.

Country-by-Country Report


CBCR is effectively a risk assessment tool for the tax authorities around the world. CBCR reports jurisdiction-wide information regarding the global revenues and income, taxes paid, assets employed, number of employees and retained earnings.

There is no small business exemption relating to the requirement to prepare the Master File and Local Country File. For CBCR, only groups of companies with global revenues in excess of Euros 750 million are required to complete and file the CBCR Template.

What Does This Mean to Your Canadian Company?


If your company is the parent of subsidiaries in other countries, you will be required to complete a Master File to be shared with your subsidiary companies for filing with their respective tax authorities, and you will also be required to complete a Local File to be maintained, along with the Master File, to be provided to the CRA if and when requested by the Agency at the commencement of an audit. Whether you need to complete the CBCR Template will depend on whether your global revenues exceed Euros 750 million or approximately CA$1 billion. If so, this Template would actually be filed with the CRA no later than one year after the end of the tax year in question. The CRA would share this information with the other relevant tax authorities.

If your company is a subsidiary of a parent company elsewhere in the world, you will be responsible for preparing and maintaining the Local File, while relying on your parent company to provide you with the Master File. The CBCR Template would be filed by the parent company with its local tax authority, to be shared with the CRA and other tax authorities in accordance with the guidance put forth by the OECD.

CANADIAN SPECIFIC REQUIREMENTS


The CRA issued three Transfer Pricing Memorandum (“TPM”) to provide its guidance with respect to certain transfer pricing issues: revised TPM-05R, Requests for Contemporaneous Documentation; TPM-15, Intra-Group Services and Section 247; and, TPM-16, Role of Multiple Year Data in Transfer Pricing Analyses.

From your perspective TPM-05R, clarifies the CRA’s expectations regarding your company’s response to a CRA request to provide your contemporaneous documentation to the Agency. The main take away for you and your company is that the CRA expects that some level of documentation will be prepared and maintained for each taxation year. Even if your company has a Study for its 2014 taxation year, the CRA will expect some form of documentation for 2015. That may mean the preparation of a Memo that confirms there have been no material changes in 2015 to all of the factual information in the 2014 Study, and testing the 2015 results against any benchmarks use in the Study.

TPM-15 elaborates on certain requirements for the analysis of intra-group service charges as set out in the Information Circular on transfer pricing, with more discussion about the use of mark-ups to reflect how arm’s length parties would charge fees for a given service to recover their costs plus an element of profit. Your company’s documentation may need to be revised to justify and support charging or paying a services fee that includes a mark-up.

TPM-16 confirms the CRA’s long held position that when you are setting your company’s transfer prices, and later testing and documenting them, the CRA expects you to use the results of a single year of data from comparable company information, as opposed to averaging multiple years of data.

WHAT SHOULD YOU DO?


Given the increasing focus on transfer pricing, both here in Canada and around the world, now is the perfect time to take stock of how your company sets its transfer prices for all of its intercompany transactions, and what support you have on file to support a conclusion that your company made a “reasonable effort to determine and use arm’s length prices or allocations.”

Note: I have disabled the comment/question feature of the Blog. I just do not have the time to answer questions during income tax season (this includes emails to my BBC or business email accounts). If you have questions or wish to engage Dan, his information is below.

Dan McGeown is a transfer pricing specialist and the National Practice Leader of BDO’s Transfer Pricing team, a team comprised of accountants and economists providing transfer pricing planning, compliance and controversy management services to a wide variety of companies having cross border transactions with related parties. You can reach Dan by phone at 416-369-3127 or by email at dmcgeown@bdo.ca.

This site provides general information on various tax issues and other matters. The information is not intended to constitute professional advice and may not be appropriate for a specific individual or fact situation. It is written by the author solely in their personal capacity and cannot be attributed to the accounting firm with which they are affiliated. It is not intended to constitute professional advice, and neither the author nor the firm with which the author is associated shall accept any liability in respect of any reliance on the information contained herein. Readers should always consult with their professional advisors in respect of their particular situation.

Monday, April 13, 2015

Confessions of a Tax Accountant

From the inception of my blog, I have written a weekly confessional during income tax season discussing interesting or contentious income tax and filing issues. This year I have abandoned the "confessions" as I figured I would probably just complain about the Foreign Reporting T1135 Form for six straight weeks – and I did not want to inflict this upon you. However, today for old time's sake, I will bring back the confessions for a guest appearance.

As usual, I only received about 40% of my client's tax returns before April 1st as they were waiting for their T3 and T5013 slips (by the way, the fact the T5013 essentially only has numerical  boxes with no written descriptions drives most accountants mad). For many of the returns that arrived before March 31st I did not even attempt to complete them because I knew there were additional tax slips to come. I must get 15 emails a day with the email header “opps, I just received another tax slip”. No one cares about this other than accountants who have to do all their work in a condensed three-week period, so I will stop the whining now. This is why I stopped with these confessions, it just provides me a license to grumble.

In all honesty, there have not been that many new issues this tax season. The same old issues are always there. For many accountants, the biggest issue is how much time they spend chasing down information and preparing the T1135 Form, let alone the additional cost to clients. However, one new issue that has arisen a few times this year, as result of the Family Tax Cut, is co-coordinating the family claim when spouses and/or common law spouses use different accountants, or one spouse prepares their return themselves. I write about this issue below.

An Accountant for each Spouse


Do you and your spouse have your tax returns prepared by different accountants or is one of you a do-it-yourselfer? If so, I suggest, (especially if your family can access the family tax cut) you reconsider this decision next year, as you may be missing out on some significant tax savings.

Spouses may choose to use separate accountants for some of the following reasons:
  • secrecy
  • a spouse may like to keep his/her finances separate (i.e. he/she only contributes to a joint account to pay household expenses)
  • one of the spouses really likes his/her accountant and has a history with them and does not want to change accountants.
Using two accountants may result in either the family not utilizing all its tax credits and deductions or the more common issue, they duplicate claiming credits and deductions; which may cause the CRA to re-assess and/or request family information that is often time consuming to obtain and provide.

This year the possible dysfunction in using two accountants has been exacerbated with the family tax cut. Now, a decision must be made as to which spouse will make the claim and the claimant requires various tax information from their spouse that is not readily available to the accountant preparing the return.

In addition to the family tax cut, a couple will benefit from a single accountant preparing both returns in respect of these deductions and credits:

a) Child care expense

b) Child credits such as the fitness and arts credits

c) Medical expenses

d) Charitable donations

Furthermore, where you and your spouse have joint investment accounts and don’t use the same accountant, it is cumbersome to report split interest, dividend and capital gains income. In these cases, there is often either duplication in reporting income or one spouse misses reporting their ½ of their income entirely.

For the reasons I note above, let alone the extra tax preparation costs, I suggest you and your spouse or partner consider using the same accountant to effectively capitalize on the spousal and/or family benefits.

This site provides general information on various tax issues and other matters. The information is not intended to constitute professional advice and may not be appropriate for a specific individual or fact situation. It is written by the author solely in their personal capacity and cannot be attributed to the accounting firm with which they are affiliated. It is not intended to constitute professional advice, and neither the author nor the firm with which the author is associated shall accept any liability in respect of any reliance on the information contained herein. Readers should always consult with their professional advisors in respect of their particular situation.

Monday, April 6, 2015

T1135 Foreign Reporting Form – 2014 Update

The T1135 Foreign Income Verification Statement has to be the most problematic tax form in history. Readers of my blog know that I have written multiple times on this topic and will do so again today, to update you about the changes to the form for 2014. Not only has the form and the reporting requirements changed several times over the last couple of years, the form continues to cause confusion for taxpayers and professional accountants alike. I understand there are still ongoing discussions with the Canada Revenue Agency by representatives of both the accounting and investment industries, as the form is still considered to be too complicated by many.

Complicated or not, the form and rules have changed for 2014 and I provide below a quick review of the rules and discuss some of the changes for 2014.

The General Rule


The T1135 must be filed by individuals, corporations, trusts and certain other persons who own specified foreign property ("SFP") costing in total more than $100,000 CAD at any time during the year. Note the word costing. That means you use the adjusted cost base, not the fair market value of the investment.

Exceptions

Some common exceptions to the reporting requirements are as follows:

  •  RRSPs are not reportable
  • Foreign property held in a Canadian mutual fund is not reportable. E.g.: Even if the Canadian fund owns U.S. stocks, the fund is not reportable.
  • U.S. cash held in a Canadian Institution is not reportable.
  • Personal use property (e.g. Florida Condo) that is used exclusively by the taxpayer as a vacation property is not reportable. However, foreign personal use real estate can get complicated. If for example, you rent out the property for eight months of the year with a reasonable expectation of profit and use the property for personal use the other four months it must be reported. However, if the property is rented out for part of the year without a reasonable expectation of profit, (just for the purpose of recovering a portion of condominium expenses) than the property is most likely not reportable. If unsure, I would suggest you file the form to be safe.

Extension of Reassessment Period


It is very important to note that the reassessment period, starting in 2013, is extended for three additional years if the following conditions are met:
  • you failed to report income from a SFP on an income tax return and
  • the T1135 was not filed, was not filed on time, or was filed inaccurately.
Thus, missing just one minor investment might be sufficient to extend your assessment period a further 3 years.

Changes for 2014 T1135 Reporting


The following are some of the key changes for 2014:

  • The form can be Efiled by individuals
  • The option to check the box where income is reported on a T3 or T5 is no longer available
  • A revised aggregate reporting method is available, but is much more complicated than last year’s version
  • For accounts with Canadian registered securities dealers or federally or provincially regulated trust companies, there are now two choices:

(1) Under Category #2, enter the Country Code, maximum cost during the year, cost at year-end,income (loss) and gain (loss) if applicable for each individual investment or

(2) Use the 2014 aggregate reporting method (i.e.: report by country for each investment account, rather than for each individual stock and bond held in the investment account as per #1 above). So for example. If you have an account with say TD Bank and in that account are 5 stocks, companies A,B,C,D&E, you can either report the details of A,B,C,D&E individually or just report A-E as an aggregate which is far simpler (subject to the country by country reporting discussed below).

For the aggregate reporting method you will use Category 7 of the form and you will be required to report the following details in aggregate for each investment account:

  • The highest Fair Market Value (“FMV”) during the year (which can be highest month end FMV) of foreign property
  • FMV of foreign property at year end
  • Gains/losses on the SFP for each investment account being reported
  • Income/loss on SFP for each investment account being reported
Again, because you can report using the FMV under Category 7, which can be taken directly off your monthly investment statements, it is typically a far simpler choice than using Category 2 which requires you to use a cost basis which most people have to dig up from old records.


Country Reporting


For 2014 you must segregate the category 7 amounts by country.

  • The country determination will generally be where the company/trust/issuer is resident (easier said than determined in many cases)
  • If you can’t determine the country of residence, the CRA says it is acceptable to use “other” for country
  • You will be pleased to know you are required to work through SFP on a country-by-country basis to determine which month is highest, and then report that balance.

Foreign Exchange Conversions


As discussed in my blog post last week, if your financial institution or investment firm does not do this for you, you will need to convert foreign holdings to Canadian dollars as follows:

  • For highest month-end FMV – can use average rate
  • For the FMV at year-end – use the closing rate
  • For the income/(loss) – can use average rate
  • For capital gains/losses – you are required to calculate gains on schedule 3 using historical rate. The T1135 capital gains should agree to what you report on schedule 3 of your return.



Many had hoped that the various concerns of taxpayers, accountants and financial institutions would have caused the CRA to simplify this form. However, as you can see, the T1135 is just getting more and more complicated.

Note: As I discussed last week, I have disabled the comment/question feature of the Blog. I just do not have the time to answer questions during income tax season (this includes emails to my BBC or business email accounts). I know this will not be popular in respect of this post, based on the fact I have had over 225 questions and comments on my prior T1135 blog posts. I apologize in advance and thank you for your understanding. Hopefully the link I provide below will answer any questions you have.

Since I am not answering your questions, I will direct you to the Chartered Professional Accountants of Canada blog, that answers many questions. Hit the link to "list" in the second paragraph. There are 143 questions asked about the form, many for which the CRA provides a response.

This site provides general information on various tax issues and other matters. The information is not intended to constitute professional advice and may not be appropriate for a specific individual or fact situation. It is written by the author solely in their personal capacity and cannot be attributed to the accounting firm with which they are affiliated. It is not intended to constitute professional advice, and neither the author nor the firm with which the author is associated shall accept any liability in respect of any reliance on the information contained herein. Readers should always consult with their professional advisors in respect of their particular situation.

Monday, March 30, 2015

Foreign Exchange Translation on Capital Gains and Dividends

One question that constantly arises during income tax season is; what exchange rate should be applied to foreign transactions? The Canada Revenue Agency ("CRA") has re-iterated/set forth their position in respect of the translation requirements for capital gains and dividends and I discuss their views below.

Capital Gains


During a roundtable discussion at the October 2014 Association de Planification Fiscale et Financière (APFF) conference, the CRA was asked the following question:

Principales Questions: What is the CRA's position with respect to the use of average foreign exchange rates for the conversion of amounts of income and capital gains?

Position Adoptée: An average rate may be acceptable for items of income, but not for capital gains.

Raisons: The definition of relevant spot rate in subsection 261(1) provides that a rate other than the rate quoted at noon by the Bank of Canada at the relevant date may be used, provided it is acceptable to the Minister.

The above comment reflects that the CRA typically accepts the use of an average yearly rate for income items (dividends etc.) but expects you to use the Bank of Canada noon rate or other acceptable exchange rate in effect at the time of purchase and sale for any capital transaction.

While I would suggest that most accountants strive for reporting capital gains in this manner, many financial institutions and investment managers do not provide such information when they provide capital gain/loss summaries and thus, such reporting can be problematic. See this blog post by Justin Bender for an example of how financial institutions often report U.S. capital gains transactions.

I have also observed that when individual taxpayers prepare their own returns, very few report using the rate in effect at the time and most use an average exchange rate for the year for their capital gains reporting. Ignoring the ease of preparation, using an average rate can result in a significant under/over reporting of capital gains/losses where exchange rates fluctuate significantly.

I would thus suggest, you attempt to adhere to the CRA’s position of using the rate in effect at the date of transaction, especially for specific large transactions.

Dividends


As noted above, the CRA stated at the roundtable that an average rate may be acceptable for items of income. John Heinzl of The Globe and Mail addressed this issue in a recent Q&A column.

Here is the question and answer.

Q: I hold some U.S. stocks in a non-registered account and pay U.S. withholding tax of 15 per cent on the dividends. My tax slips provide the dividend and tax information in U.S. dollars. Given the currency fluctuations we’ve seen recently, how do I report these amounts on my Canadian income tax return?

A: Because U.S. dividends do not qualify for the Canadian dividend tax credit, in a non-registered account you would pay Canadian tax at your marginal rate on the full amount of the U.S. dividend – just as if it were interest income. To avoid double taxation, you may be able to claim the 15-per-cent U.S. tax withheld as a foreign tax credit on line 405 of your return.

For tax purposes, you’re required to convert foreign income and foreign tax withheld to Canadian dollars, using the Bank of Canada exchange rate in effect on the transaction date.

However, according to the Canada Revenue Agency, if there were “multiple payments at different times during the year,” it is acceptable to use the average annual exchange rate. This simplifies the process of converting U.S. dividends and tax withheld to Canadian dollars.

You can find a list of average annual exchange rates on the Bank of Canada website.

Between the foreign exchange compliance and the T1135 Foreign Reporting requirements (see next week's blog post), it is enough to make one want to keep all their investments in Canada to avoid the complications of tax reporting :)

Note: I have disabled the comment and question feature on the blog. Unfortunately, I just do not have the time to answer questions during income tax season. I will enable comments in May. Thank you for your understanding.

Money Sense - Retire Rich 2015 Giveaway


On April 8th in Oakville, Money Sense is presenting “Retire Rich 2015” a four hour evening of wealth-building insights and practical advice, in which you’ll learn the proven tactics and strategies that can help any Canadian establish a low-cost retirement plan for a rich and rewarding retirement.

The presenters include Bruce Sellery, Duncan Hood, Preet Banerjee and Dan Bortolotti, four of Canada’s leading retirement-planning experts.

Money Sense has provided me 6 tickets to giveaway to my readers. If you are interested, please send me an email to bluntbeancounter@gmail.com by April 3rd and I will select three winners (2 tickets each).

If you wish to learn about the event or register, here is the link.

This site provides general information on various tax issues and other matters. The information is not intended to constitute professional advice and may not be appropriate for a specific individual or fact situation. It is written by the author solely in their personal capacity and cannot be attributed to the accounting firm with which they are affiliated. It is not intended to constitute professional advice, and neither the author nor the firm with which the author is associated shall accept any liability in respect of any reliance on the information contained herein. Readers should always consult with their professional advisors in respect of their particular situation.

Monday, March 23, 2015

The Trials and Tribulations of an Infant Business

A few weeks ago, you may have read my blog post on the new Ontario Retirement Pension Plan. The post discussed who would be considered an employee (required to join the plan) vs self-employed (excluded from the plan). One of my readers, we will call him Joe Business commented as follows:

"I'm not sure what makes me angrier. That I'm forced to incorporate to get contract jobs with Canadian banks (otherwise I'm not considered) or:
  • that I've been over-saving since I was 19 years old and will have more than enough saved for retirement when I turn 62
  • that I'm losing $3,420 to the government for a program I do not want or need
  • that my self-employed one-employee corporation is not exempted (though others are), clearly pushing me to pay myself dividends only (which puts me at risk of being labelled a PSB which I'd rather avoid).
I will refrain from submitting any comments until I can do so politely."

Joe voiced many of the various frustrations small business owners’ face, so I half-jokingly suggested to him; "maybe you can write me a guest blog on the travails of a one person corporation; you are off to a good start :)".

Surprisingly, Joe took me up on this offer and below he writes about the trials and tribulations of an infant business. As someone who deals with small business owners on a day to day basis, I found his post candid and representative of what I often hear.

I hope you enjoy his post. However, first the obligatory caveat. Joe's views are his own and not necessarily representative of mine nor any firm I am affiliated with.

The Trials and Tribulations of an Infant Business 

by Joe Business


I believe every corporation’s birth story deserves to be told. Every company started as someone’s baby with the most honourable goal of creating something pure, something new, or possibly to avoid taxes/personal liability. So when Mark suggested I write a few words on my baby’s first steps, it was a father’s dream.

It all started with a Kickstarter campaign in February 2014. I had the optimistic goal of getting free money from strangers to create an innovative product. As any Kickstarter funds I received would be included as income at my highest personal tax rate, I decided to incorporate to access the small business deduction. Thirty minutes and $200 later, the corporate entity was born.

For the Kickstarter campaign, I needed a corporate (non-personal) chequing account to receive all those oodles of money these strangers were going to send me. I wanted to find the cheapest corporate account I could find, as I did not expect to have that many transactions, save the sweet glorious cash Kickstarter would deposit into the account (less the 15.5% in small business taxes). Despite some hesitancy, RBC account managers confirmed they offered a free eBusiness account though that was clearly not their preferred option. By the way, going with one of the big 5 banks makes it much easier to pay the CRA later on (though I didn't know this yet).

Within minutes my Kickstarter campaign had begun! And then it ended. Prematurely; because I was embarrassed no one but my wife had pledged after a month. You might even say it was a dismal failure.

Months later I still owned this worthless corporate legal entity, but as it happened, a recruiter found me on LinkedIn and offered me a contract position as a consultant. There was a clear preference to deal with a corporation rather than a sole proprietor and all invoicing had to go through a third party. Rather than pay a lawyer, I read the forty pages of legalese and determined it was mostly written to shield the client from any and all liability. I decided then that if I was going to go down this path, I had to believe the client found value in my services.

My wife wasn't happy with this new arrangement since I was giving up a perfectly adequate full time position. But with all my coworkers getting laid off, it did seem like an optimal time to jump ship. And so my foray into self-employment had begun!

I hired an accountant right away based on a localized Google search. I picked the second one I found because he had fewer online reviews than the first and I assumed I’d get more focused attention with him. This sounds unwise in hindsight. Despite my lack of due diligence, he easily saved me several headaches and avoided a 30% kiddie tax on dividends in our first meeting, so I guess I got lucky.

My new job started and to date has worked out. That part was easy.

But recently, the CRA has been auditing IT contractors calling them “Personal Service Businesses ("PSB")” or basically, incorporated employees. As I understand, where the CRA reassesses your business as a PSB, you are essentially allowed no deductions other than salary and as result, your ultimate tax rate can approach 59%.

I know of a family friend who fought and ultimately won against the CRA in a similar disagreement; but it had dragged out for almost 10 years in delays and appeals. Even winning can result in a severely weakened company.

I met other contractors in a similar boat but found that their accountants had never even mentioned the problems with the PSB designation.
At least three contractors only paid themselves dividends and no salary at all! Another contractor who knew of the PSB designation chose to pay himself only a salary and a large bonus if he hits his "sales" target. His repeated phrase to me was “it’s going to be really expensive when those guys get caught.”

I recently added a simple Health Spending Account (HSA) to my corporation, but even this came with headaches. The first HSA suggested by another contractor used their services and showed me an email where the administrator indicated that any money added to his HSA would never expire.

This appears to contravene the CRA who specifies some risk must be incurred to be a taxable benefit (I actually had to look through CRA archives to find out about this distinction). In this case, you might as well just pay yourself extra salary to cover the health benefits - regardless of whether it’s a valid health expense or not. Later the administrator corrected herself and said they do expire after 2 years. But by then I had gone with someone else.

The HSA I went with does something strange - any health benefits you submit must then be paid for directly by your company (plus a premium charge) and then it’s paid to your personal account (tax free). This also looks like it contravenes the CRA’s rules, except the HSA also includes a high deductible health care over $10,000 dollars. I’m not an expert but I guess this is the “risk of loss” that the health spending account requires to qualify for the CRA’s rules.

Recently, the Ontario government has introduced a new Ontario Retirement Pension Plan (ORPP) because the government does not feel the middle class can save enough on their own for retirement. This plan will guarantee retirement for the middle class at a cost of $1,720 for the employee each year, and another $1,720 you must match as an employer. For self-employed incorporated employees this will result in a $3,420 added tax on top of the $4,900 in CPP they already pay each year. Unlike other savings vehicles, the money is not accessible when the small business might need it and can't be used as loan collateral. I have no wish or need for this retirement plan. I've always saved greater than 15% of my salary since I was 19 and I have a pretty good idea what my expenses are. I've begged my MPP to allow people like me to opt out (or be exempt). At least he'll think twice before riding the Go Train again.

As I understand, I can simply pay myself dividends instead of salary to avoid this new ORPP - but that introduces a substantial risk of a 59% tax on that whole PSB label above. I'd also be forced to avoid the CPP as well.

My corporation turned one year old on February 6th. And like the little human infants who take their first steps, there are a few falls along the way. Hopefully it will grow and mature and become self-sustaining, old enough one day to leave the nest and be out on its own.

This site provides general information on various tax issues and other matters. The information is not intended to constitute professional advice and may not be appropriate for a specific individual or fact situation. It is written by the author solely in their personal capacity and cannot be attributed to the accounting firm with which they are affiliated. It is not intended to constitute professional advice, and neither the author nor the firm with which the author is associated shall accept any liability in respect of any reliance on the information contained herein. Readers should always consult with their professional advisors in respect of their particular situation.

Monday, March 16, 2015

Tax Planning for Low Oil Prices

The recent plunge in the price of oil has hurt many stock portfolios. Yet, as with most market corrections, some people see great opportunity going forward, while others see portfolio pain.


As an accountant I cannot provide investment advice and thus will not state my opinion on where I see the price of oil going. However, I can provide income tax planning advice, and today I give you two tax planning considerations in relation to the price of oil.

Tax-Loss Selling


The first tax planning consideration is whether or not you should sell some of your oil and oil related stocks to realize a capital loss. Any decision to sell should not be a tax loss tail wagging the dog decision, but based on a considered investment decision by you and/or your investment advisor. 

If you decide it is prudent to sell some or your oil stocks to realize a capital loss (whether today or later in the year), you can use that loss against any capital gains you realize in 2015, or carry the loss back up to three years. I have a very detailed discussion of how to use capital losses in my blog “Tax-Loss Selling”.

Flow-Through Limited Partnership


A second, less obvious consideration, is the use of a flow-through limited partnership (“flow-through”). I had not really put my mind to this alternative until a client recently told me that they felt that the price of oil was at a bottom, or near a bottom, and was there anything they could do if they were willing to wait up to two years for a rebound. Once they said two years, a light bulb went on in my brain, as most flow-throughs must be held approximately two years until they convert to publicly sale-able stocks.

Before I get into the details, I think a quick primer on flow-throughs would be useful.

What is a Flow-Through?


An oil and gas flow-through, in very simple terms, is a limited partnership that invests in shares issued in a variety of junior oil and gas companies. The essence of this type of investment is that the partnership vehicle provides for the various oil and gas exploration deductions to “flow-through” to individual investors.

In simple terms, if you pay $10,000 for a unit of an oil and gas flow-through that is exploration based (development based flow-throughs will have lower deductions allocated), you will receive approximately $10,000 in income tax deductions that can be utilized in your personal income tax return. Most of the deductions are in year one and the remaining in year two. Assuming you are in the highest marginal tax rate, you would save almost $5,000 in taxes making your out-of-pocket cost $5,000 after claiming the flow-through deductions.

Most limited partnerships are subsequently rolled on a tax-deferred basis into a mutual fund that can be sold on the market within two years. Carrying on with our example, let’s say that in two years the limited partnership is rolled into ABC Mutual Fund and you immediately sell your unit for $10,000. The cost base of the investment is reduced to zero because of the deductions noted above, so you would owe capital gains tax of approximately $2,500 at the highest marginal tax rate ($10,000 gain x 25%). Your after-tax return on your investment would be $2,500 ($10,000 proceeds on the sale of your mutual fund, less $2,5000 tax + $5,000 tax savings − $10,000 initial cost). Flow-throughs provide some downside protection for your investment risk, as you would break even in this case in two years if you could sell your shares/mutual fund units for approximately $6,700. If you have capital loss carryforwards you do not expect to use, the flow-through becomes even more attractive as the capital gain can be offset by your capital loss carryforwards.

Of course, you and/or your advisor may feel it more prudent to purchase oil stocks or oil ETFs in lieu of a flow-through. I am just providing a tax option, not an investment opinion.

Back to my client’s original question. Since they believe the price of oil is at, or near a low, and they are willing to hold their investment for at least two years, a flow-through can be very effective in two ways. First, they will receive the income tax deductions resulting in current tax savings. Second , if they are correct in their assessment on the current and future price of oil (again, this is their thought, not my opinion) and say the partnership value grows to $15,000 within two years and they sell when the flow-through is converted to a mutual fund; using the $10,000 original purchase price from above, they will realize an after-tax return of $6,250 on their $10,000 investment ($15,000 proceeds on the sale of  the fund, less $3,750 tax plus the tax savings of  $5,000, less $10,000 initial cost).

To re-iterate; I have just set forth a tax planning option if you and/or your advisor feel it is a good time to purchase oil stocks. This is first and foremost an investment decision and I provide no guidance on such.

This site provides general information on various tax issues and other matters. The information is not intended to constitute professional advice and may not be appropriate for a specific individual or fact situation. It is written by the author solely in their personal capacity and cannot be attributed to the accounting firm with which they are affiliated. It is not intended to constitute professional advice, and neither the author nor the firm with which the author is associated shall accept any liability in respect of any reliance on the information contained herein. Readers should always consult with their professional advisors in respect of their particular situation.