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 tax partner and the managing partner of Cunningham LLP 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 do not reflect the position of Cunningham LLP. My posts are blunt, opinionated and even have a twist of humor/sarcasm. You've been warned.

Monday, October 15, 2012

Punitive Income Tax Provisions

The Income Tax Act ("Act") contains numerous punitive provisions that can catch taxpayers off-guard. Today I will review some of those provisions.

Late Filed Income Tax Returns


Many taxpayers who cannot afford to pay their income liability on April 30th or June 15th (if you are self-employed) do not file their income tax returns on time. That is the worst possible decision. The Canada Revenue Agency ("CRA") imposes a late-filing penalty of 5% of the balance owing for late filed returns and then tacks on an extra 1% a month for each full month your return is late to a maximum of 12 months. For those mathematically challenged, that is a potential  17% penalty for simply not mailing in your income tax return by the deadline. If you file on time, you will owe interest, a small cost to avoid the penalty.



If you have incurred a late-filing penalty in either of the three preceding taxation years, your late filing penalties are doubled and apply for up to 20 months for a maximum penalty of 50%. Yes, fifty percent, that is not a typo. You may be able to apply for Taxpayer Relief ("Fairness") on your penalty; however any reduction in the penalty relies upon the discretion of the fairness committee. My advice, always file on time even if you cannot afford to pay your tax liability.

Interest on Taxes Owing and Refunds


As noted above, you can easily avoid a late-filing penalty by just filing on time. Unfortunately, you cannot avoid interest on  taxes owing. Interest compounds daily at the prescribed rate on any balance of tax owing after April 30th, currently at 5% as per this CRA schedule of interest rates.

Some may find this hard to believe, but as per the above schedule of prescribed rates, the CRA only pays taxpayers filing personal income tax returns 3% on overpayments and refunds, yet charges 5% on deficient payments. Go figure.

Instalments


Per this CRA instalment guide the CRA will charge interest at the prescribed rate of 5% if you did not make instalment payments or made payments that were less than the required amounts.

You may also have to pay a penalty if your instalment payments are late or less than the required amount. The penalty only applies if your instalment interest charges are greater than $1,000. The penalty is calculated as follows:

The higher of:

■ $1,000; or
■ one-quarter of the instalment interest that you would have had to pay if you
had not made instalment payments for 2012.

The CRA then subtracts the higher amount from your actual instalment interest charges for 2012 and finally, they divide the difference by two and the result is your penalty. Since no one can follow that calculation, the CRA provides the following example:

Example

For 2012, John made instalment payments that were less than he should have
paid. As a result, he has $2,500 of actual instalment interest charges for 2012. If
John had not made any instalment payments in 2012, his instalment interest
charges would have been $3,200. Since one-quarter of $3,200 is $800, we
subtract $1,000 (the higher amount) from $2,500. The difference is $1,500. Then,
we divide $1,500 by two. John’s penalty would be $750.

There you go, clear as mud. Just pay your instalments on time, since your accountant has no clue if the instalment penalty is calculated correct or not :)

Penalty for Unreported Income (missed tax slips)


Under Subsection 163(1) of the Act, where a taxpayer has failed to report income twice within a four-year period, she/he will be subject to a 20% penalty of the amount you failed to report the second time. It is important to note that the amount of income that was unreported the first time is not relevant in the calculation. If you failed to report $100 the first time and $10,000 the second time, the penalty will be $2,000, a somewhat ludicrous result considering if the slips were missed in the reverse order the penalty would only be $20. In addition, the reality of the situation is that it is very easy for a T3/T4/T5 slip to be misplaced or lost in the mail.

I find this penalty insidious and have previously written on this issue in a couple different blogs.

T1135 penalty


Where you hold certain types of foreign property with a cost over $100,000, you must file the required T1135 Foreign Reporting Form. Where the form is not filed as required, the CRA can levy a penalty equal to $25 a day to a maximum of $2,500. The quantum of this penalty is just unconscionable where the income has been reported, but the form not filed. I can understand this penalty where the income has not been reported, however, where the income is reported, how can a penalty of such magnitude be charged?

Wow, that's all I can say when I read back my post and digest the various punitive provisions. While these provisions are necessary to ensure compliance with the Act, the quantum of many of these penalties is just obscene.

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs.

13 comments:

  1. Mark,

    My father purchased some U.S. stocks in my name long ago without telling me. He passed away a couple years ago and I have had some issues in determining the adjusted cost base of these stocks, which may or may not be over $100k U.S. I have not filed the T1135 since I am not sure I am required to. Based on the penalty, should I be filing to be safe?

    ReplyDelete
    Replies
    1. Hey Anon:

      When filing for clients, my fallback position is to always file the T1135 if we are unsure, since there really is no downside to filing, assuming you are reporting all related foreign income.

      The issue you have is if your cost base is actually greater than $100k, you could have penalties for any prior years also.

      Delete
  2. Hi Mark

    Are dividends and capital gains from stocks held in a country which does not have any tax treaties with Canada, taxed as if they were interest income ie at the highest marginal rate? What about interest income from deposits in excess of 100,000 -- how are they taxed in Canada and where would you report them?

    Thanks

    ReplyDelete
  3. Hey Be*en:

    Foreign dividends are taxed essentially the same as interest on line 121 of your return. That is because there is no dividend tax credit on foreign dividends. Consequently as you note, the foreign dividends are then taxed at your marginal rate, which may or may not be the highest rate. Capital gains whether in Canada or outside of Canada are taxed the same, 1/2 subject to tax.

    If you are a canadian resident, your worldwide income must be reported. Thus, the interest income is reported on line 121.

    ReplyDelete
  4. Hi Mark

    Good blog. You might want to discuss the onerous penalties on excess RRSP and TFSA overcontributions.1% per month in this zero interest rate environment is draconian.

    Regards,

    McTax

    ReplyDelete
    Replies
    1. Thx McTax,

      Good idea for another blog, will keep that for a rainy day :)

      Delete
  5. If Revenue Canada pays 3% on refunds owing, is there a downside to making overpayments and earning a "risk free" return of 3%? Sure beats bank savings accounts and most other fixed income investments!

    Kevin

    ReplyDelete
    Replies
    1. Hi Kevin

      Good question, interest rate is high, but they dont start paying until:

      We will pay you compound daily interest on your tax
      refund for 2011. The calculation will start on whichever of the following three dates is latest:

      ■ May 31, 2012;
      ■ the 31st day after you file your return; or
      ■ the day after you overpaid your taxes.

      Delete
  6. Hello Mark. I transferred my RRSP from BMO Nesbitt Burns in 2010 but in 2011 I received a cheque from BMO Financial Group as a settlement for a class action suit regarding their treatment of foreign exchange on previous trades. Then early in 2012 I received a T4RSP from BMO treating this as a taxable withdrawal from my RRSP and Revenue Canada now wants their ounce of flesh. I see this as reimbursement for excessive fees as opposed to income. What's your opinion?

    Thanks,
    Doug

    ReplyDelete
    Replies
    1. Hi Doug:

      Great question, unfortunately I don’t have the time to look at this in detail. If this was a client question I would probably read the court settlement and consider further. It seems to me, BMO is saying it paid the monies directly to you personally and since the RRSP does not exist anymore, the payment to you was effectively a withdrawal from your RRSP. So, without much consideration, I think BMO has treated this properly.

      Think of it this way. If you had a reimbursement into your RRSP, there would have been no T4 RSP, but if you had the RSP and then took those monies as a RRSP withdrawal, BMO would have issued a T4 RSP, the same thing they are doing now.

      You probably don’t care, but the question is more interesting if you had a non-registered account. The reality of the situation would be that you may have had some F/X transactions where you were short-changed on capital transactions and some on income transactions, so how do you deal with that?

      Delete
  7. Hi Mark, If my employer is US corporation with a branch in Canada (also a legal Canadian entity), how is my employee stock *and* Restricted Stock Units (RSUs) are treated as far as foreign property is concerned? Do i have to file T1135 ?
    Also, since RSUs don't have any cost basis to me, does it really matter?
    thanks

    ReplyDelete
  8. Hi Mark,
    If RSU are getting vested with say FMV of 50k . However cost for me is NiL. Do I have to report on T1135 if with my other assest , value of my foreign assest is more then CAD 100K

    ReplyDelete