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RESIDENCE of INDIVIDUALS

ISSUE A threshold issue is whether _____ is subject to tax under the Income Tax Act “ITA”RULES Income tax is a tax on the income of a tax unit. S. 2(1) of the Act provides that income tax is payable on the

taxable income of “every person resident in Canada at any time of the year.” Accordingly, it must be determined whether _________ is “resident in Canada” for the purposes of the Act.

o DEFN TAXABLE INCOME: 2(2) The taxable income of a taxpayer for a taxation year is the taxpayer’s income for the year plus the additions and minus the deductions permitted by Division C.

o WORLDWIDE INCOME: 3(a) Residents are taxed on worldwide income (income “from a source inside or outside Canada”) including from office, employment, business and property. Part I; a progressive rate structure.

While “Residence” is not expressly defined in the Act, the meaning of the term has been interpreted applied in case law

It is assumed that for the purposes of tax legislation, every person has at all times a residence (Thomas v MNR) In Thomas,the SCC found that residence “depends on the spatial bounds within which a person spends his or

her life or to which his or her ordered or customary living is related”. It is not necessary for one to have a home, place of abode or shelter – although it is a facto to consider. One is “ordinarily resident” where they are in a settled routine of his or her life.

In Allchin, the TCC also noted that the presence of one’s family is a primary factor. (ITF 1.11). However, compare with Shih (Taiwan), Shujahn (selling house), Nicholson (divorced).

As per Thomson, the intention of the taxpayer, while perhaps relevant, is not determinative. Draw in any other relevant law from cases below.

APPLY Apply the facts of the given fact pattern – compare to other cases. FACTORS CONSIDERED BY COURT

The residential ties of an individual [per Income Tax Folio – while although not law, does provide factors for the court to consider] that will almost always be significant residential ties for the purpose of determining status are:

Dwelling place Spouse or common law partner; Dependents

Courts will also consider• Personal property in Canada (furniture, clothing, automobiles, recreational vehicles)• Social ties (memberships in Cdn recreational and religious organizations)• Economic ties (employment with a Cdn employer and active involvement in a Cdn business, and Cdn bank

accounts, RSPs, credit cards, and securities accounts)• Landed immigrant status or appropriate work permits in Can• Hospitalization and medical insurance coverage • Driver’s license• Vehicle registration• Seasonal dwelling place in Can or a leased dwelling place referred• Passport• Memberships in Canadian unions or professional organizations

And also considered per Income Tax Folio S5-F1-C1 (para. 1.15):• Cdn mailing address,• Post office or safety deposit box, • Personal stationery (biz cards) showing a Cdn address,• Canada telephone listings

Canadian newspaper and magazine subscriptionsCASE LAW ON RESIDENTS

Thomson v MNRFacts: Sold home in New Brunswick and announced4 Bermuda as residence – but then spent little time in Bermuda. He spent most of his time in the US where had a home available for occupancy year round. He began to regularly return to NB for 4 to 5 months every year and built a house that he kept available all year long. His wife and children accompanied him on his regular visits. Principles: he is a “home: - and the mere limitation of times does not qualify that fact. Held: Majority clearly felt that Thomason was resident in the US and Canada

Key Points: (1) for the purposes of income tax legislation, it must be assumed that every person has at all times a residence(2) it is not necessary for residence that a person have a home, place of abode or shelter. (3) one is “ordinarily resident” in the place where in the settled routine of his life he regularly, normally or customarily lives(4) there may be more than one place where a person normally or customarily lives(5) the intention of a taxpayer (to be resident in Bermuda) is perhaps relevant but not determinativeBeament v MNRFacts: Taxpayer posted overseas with the Canadian army at the beginning of WWII in 1939. Stayed till 1945 with one short visit to Canada for a few weeks in 1941. Married in English, had children there and established a matrimonial home there. Held: the taxpayer was NOT resident in Canada until he returned in 1946.Principles: (1) absence of any home in Canada which could return as of right was a factor tending to indicate he was not resident in Canada. (2) intention is not determinative – the taxpayer had always regarded his absence from Canada as temporary – but still not held to be a resident. Russell v MNRFacts: Taxpayer absent from Canada for several years on war service but maintained a matrimonial home and family in Canada. Held: Resident in CanadaPrinciple: physical presence in Canada not necessary to be found to be a residentNote: this case suggests that having a home in Canada tends to be a strong factor suggesting residence in Canada.Allchin v RFacts: Taxpayer worked in the US from 1992 – 1997. She stayed with friends in the US, set up a US bank account, had credit cards sent to the US address and attempted to move her family to the US BUT her husband and children lived in Canada, she continued to have on Ontario driver’s license, Ontario health insurance, club membership in Ontario, her husband swore an affidavit that she was resident when they purchase the property.Held: Resident in Canada from 1993 – 1995

CASE LAW ON NOT RESIDENTSShih v RFacts: S immigrated to Canada with wife and three sons and purchased a home in Canada BUT he returned to Taiwan. S visited Canada but with stays totaling at most 59 days in any given year. He had residential ties to Taiwan, a family member in Taiwan and a job in Taiwan. Held: wife and sons in Canada not strong enough in light of other factors to make him resident in CanadaSchujahn v MNRFacts: Transferred to US Aug 2, 1957. Left Canada and put house up for sale but wife and child stayed in house until it was sold in February of 1958. Issue: Was the taxpayer resident for the whole of 1957 or just until Aug 2, 1957?Held: taxpayer had given up residence on August 2, 1957 – wife and children in house until sold was reasonable for purposes of facilitating sale of house. Hauser v RFacts:

• Air Canada pilot 1992-1995 worked as a flight instructor in Florida• 1996 divorced and returned to Canada renting an apt. briefly in Cambridge• 1997 gets residence permit for the Bahamas and moves there with new wife• shipped household goods, car and boat to Bahamas• opened a bank account in the Bahamas• couple spent Christmas holidays in Canada - wife spent hurricane season in Canada• Hauser remained an Air Canada pilot• held a Transport Canada license• belonged to a Canadian chapter of an international pilot’s union• kept joint bank account in Cambridge, Ont. where his Air Canada salary deposited

Held: He remained resident in CanadaPrinciples to remember:

If one is trying to abandon Canadian residence, then ties to foreign jurisdiction relevant to establishing residence outside Canada – where there are limited ties to Canada then evidence of settled routine of life elsewhere is relevant.

BUT proof of residence elsewhere does not mean one is not resident in Canada (because one can be resident in more than one country)

RESIDENCE OF A CORPORATIONISSUE The issue is whether a corporation is “resident” in Canada for the purpose of the ITARULES – STAT PROVISIONS

Income tax is a tax on the income of a tax unit. S. 2(1) of the Act provides that income tax is payable on the taxable income of “every person resident in Canada at any time of the year.” Accordingly, it must be determined whether _________ is “resident in Canada” for the purposes of the Act.

o DEFN TAXABLE INCOME: 2(2) The taxable income of a taxpayer for a taxation year is the taxpayer’s income for the year plus the additions and minus the deductions permitted by Division C.

o WORLDWIDE INCOME: 3(a) Residents are taxed on worldwide income (income “from a source inside or outside Canada”) including from office, employment, business and property. Part I; a progressive rate structure.

o Persons under s. 2(1) includes a corporation, as corporation is regarded as a person for the purposes of the ITA under s. 248(1).

Deemed residency: corporations incorporated in Canada on or after April 16, 1956 per s. 250(4) of the ITA are deemed to be residents of Canada

o A corporation in Canada before April 26, 2965 is a resident in Canada per s. 250(4)(c) if;(i) It has carried on business in Canada after that date; or(ii) It is a resident under the common law rule

COMMON LAW

A corporation is resident wherever “the central management and control actually abides”. (DeBeers. This is usually where the board of directors meets. (DeBeers). The directors’ location is generally determinative, unless their power has been “usurped”. (Wood)

o When the shareholders dictate the directors’ actions (e.g. where there is a majority shareholding company), the test is where the shareholders reside. (Unit Construction)

Central management and control test:o De facto. Where does control actually reside? (not merely de jure) (Unit Construction)o Even when the location is selected for tax avoidance and the corp does all of its business in Canada, if

the directors are non-Canadian and non-usurped, it’s not a Canadian resident. (Wood). This indicates a high degree of formalization of the test.

CASE LAW ON OLD COMMON LAWDe Beers Consolidated Mines v HowerFacts:

corporation incorporated in South Africa head office in SA carried on mining business in SA majority of board of directors lived in England, met in England and managed all policy decisions in England

Held: the corporation was resident in England. Note: This was the case that first set out the test that a corporation was resident where its control and management resided. Unit Construction Co v BullockFacts:

three corporations were incorporated in Kenya – carried on business in Kenya – directors resided and met in Kenya the three corporations were subsidiaries of an English corporation and were effectively controlled from England by the

directors of the parent corporationHeld: location of central management and control was a question of fact – the location of central management and control was England.

RESIDENCE OF TRUSTS ISSUE The issue is whether a trust is a resident of Canada for the purposes of the ITARULES – STAT PROVISIONS

s. 104(1), 248(1) when the ITA refers to at rust, they are referring to a trustee s. 104(2) trusts are deemed to be individuals and taxed accordinly CRA position is that a trust resides where the management and control of the trust resides – which will depend

on the residence of the individual trustee (not law – but a factor to consider)GENERAL TEST

The trust resides where the trustee resides

MULTIPLE TRUSTEES

The law here is unclear – CRA uses the same test as Garron. The central management and control test has been applied.

CASE LAW ON THIS TOPICThibodeau Family trust v The QueenFacts:

three trustees – two lived in Bermuda – third lived in Canada Minister assessed the trust as a Canadian resident – reason was that Canadian trustee was a member of the family for

whom the trust had been established – was chief executive officer of a corporation owned by the trust and was active and influential in the investment program of the trust

BUT the trust instrument allowed a majority of the trustees to make decisions binding on the trust – the day to day management was carried out in Bermuda by the Bermuda trustees and evidence that they did not always follow the wishes of the Canadian trustee

Meetings of the trustee held in BermudaHeld: the trust was resident in Bermuda, not Canada, because the trust decisions were, per the trust deed, to be made by a majority of the the trustees and 2/3 trustees resided in Bermuda.

• the trustees in Bermuda actually did control the trust because they held meetings in Bermuda, made decisions by majority, and did not always follow wishes of the Canadian trustee

Notes: “The [de facto central management and control test], in my view, cannot apply to trustees because trustees cannot delegate any of their authority to co-trustees. A trustee cannot adopt a ‘policy of masterly inactivity’ …”Garon v the Queen Principle : held that test of residence of a trust should be determined by the principle that a trust resides for the purposes of the Act where, borrowing the language from De Beers, “its real business is carried on” and saying that that “is where the central management and control of the trust actually takes place”

NON-RESIDENTS NON RESIDENTS PAY TAX IF:

2(3) Where a person who is not taxable under 2(1) for a taxation year(a) was employed in Canada (b) carried on business in Canada, or(c) disposed of a taxable Canadian property,

income tax shall be paid on the person’s taxable income earned in Canada in accordance with Div D

115 in Division D outlines “taxable income earned in Canada by non-residents”; also PART I tax so progressive

SOJOURNINGISSUE Is the person a resident in Canada, for tax purposes because of the act of Sojourning?RULES Per s. 250(1)(a) a person is deemed to be a resident of Canada if the person “sojourns” in Canada for 183 day

Sojourn means a “temporary stay” – it is something less than residence. You are present in Canada on a more transient basis

Effect of sojourning: you are deemed a resident of Canada per s. 250(1)(a) and you are taxed on your world wide income – presumably on the policy consideration that if you are in Canada for this long of a period of time then you should contribute to the services of the government.

You may still be a resident if you are in Canada for less than 183 days (Thomson) Physical presence is necessary for sojourning but not for residency (Russel)

DEPARTURE TAX AND PART TIME RESIDENCEISSUE The issue is whether part time residence or departure tax provisions should apply here?RULES – PART TIME RESIDENCE

Corporations: per s. 114 are taxed on their world wide income for the entire year Individuals: s. 114 provides some relief – only taxed on their world-wide income for the part of the year that

they were resident in CanadaRULES – Departure tax: is imposed by deeming a disposition of capital property on persons who give up Canadian

DEPARTURE TAX

residence – upon ceasing to be resident they are deemed to have disposed of property at fair market value immediately before ceasing to be resident – this is to recognize the capital gains for tax purposes – before the person departs

Excluded from deemed disposition of property is real property in Canada, capital property used in Canada, rights to receive payments from an RRSP

No deemed disposition for any person who were resident for 60 months or less during the previous 10 years for any property they owned

TAX TREATIESISSUE The issue is whether X is a resident in Canada and another country and which tax treaty will apply?DEFINITION A person may be found to be a resident in Canada and another country. RULES The tie breaker rules for individuals address:

Place of permanent home center of vital interests (where the persons personal and economic relations are closest) habitual abode nationality mutual agreement

In regards to corporations the tie breaker rules usually refer to: place of management and control place of incorporation mutual agreement by authorities

STAT s. 250(5) makes it clear that where a person would otherwise by resident in Canada, but they are deemed not to be by virtue of a tax treaty, they are not a resident in Canada for the purposes of the ITA

PROVINCIAL ALLOCATIONISSUE The issue is the allocation or provincial tax for individuals or corporations. INDIVIDUAL RULES

Reg 2601: provides that for an INDIVIDUAL the province in which they were resident the last day of the taxation year is entitled to tax the individuals on the entire income

Individuals with business income – the business income is attributed to the province where the permanent establishment is – where there are multiple locations reg 2603 provides rules for apportioning the income between provinces.

Reg 2607 where the individual is resident in more than one province on the last day of the year, the individual is to be deemed to have resided on that day, only in the province that may reasonably be regarded as his principal place of residence

CORPORATION RULES

Reg 2607: allocates the income to the province in which the corporation had a permanent establishment in the taxation year – where it had a permanent establishment in more than one province – there are rules for apportioning the income

TRUSTS RULES the regulations do not provide for trust residence allocation between provinces but trusts are treated as individuals per. S104(2) thus the rule regarding individuals are applicable. `

FACTORS FOR INDIVIDUALS

In Mandrusiak the court considered: drivers license spending Christmas/new years in Alberta chief source of income family location overall social contacts in Alberta

THE CONCEPT OF INCOMEISSUE The issue is to determine if (X) qualifies as income for the purposes of the ITA, and whether it constitutes

income from a source, enumerated or unenumerated. RULE Defined: Income is not defined in the Act. Case law indidcates that it is a net concept – it is the net of

expenses incurred in the generation of that income. This concept of income reflect the policy rationale of taxing accretions to wealth and tracking taxpayers ability to pay. The identification of an amount as income is important for tax policy and will affect the income tax base.

Source: While the ITA does not specifically define income, it indicates in s. 3(a) that income is from a source. S. 3(a) enumerated four sources of income: office, employment, business or property

The ITA provides a set of rules for the determination of income from these enumerated sources – subdivision a (ss. 5-8)b has rule for income from office and employment, subdivision d (ss. 9-37) has rules on business and property

APPLY (X) is income from [source] and is governed by rules [x] where as _____ RULE UNENUMERATED

S. 3(a) prefaces the four enumerated sources with the phrase “without restricting the generality of the foregoing”. Thus while income must come from a source, the sources may extend beyond the four listed

S. 56 supoorts this, which states that the other types of income listed: including pension and EI benefits, do not restrict the generality of s. 3.

In Fries and Schwartz the court explicitly recognized unenumerated sources. Courts are hesitant to state that they are from an unenumerated source because there are not specific

rules to govern themCASE LAW ON UNENUMERATED SOURCES

Canada v FriesFacts

Fries was an employee of the Saskatchewan Liquor Board and a member of the Saskatchewan Government Emplyoee’s Union

Went on strike and received strike pay equal in amount to his normal net take home. Held

Strike pay is NOT ‘income from a source’ per s. 3 (employment, property, business) Court is hesitant to add it as income form another unenumerated source

Schwartz v CanadaFacts

Taxpayer agreed to take senior position with Dynacare under written employment contract. Before the employment commenced Dynacare advised that Schwartz’s services would not be needed. Taxpayer accepted a lump sum payment of $360,000 plus $40,000 in legal costs. Minister included the compensation as a retiring allowance

Key Points1. explicit recognition of unenumerated sources2. payment of damages for breach of contract was not income from a source caught by the ActHeld

Majority agreed that s 3(a) list of sources is not exhaustive – unenumerated sources are included Payment of damages for breach of contract is NOT taxable The payment is not income from an enumerated source of employment – it is a non taxable windfall. However, did agree that office, employment and business, property are not the only sources of income.

Fortino v the QueenFacts

Taxpayers sold shares in Fortino’s Supermarket Ltd to Loblaws and entered into non-competition agreement restricting taxpayers from competing with Loblaws within a specified area for five years.

Minister initially assessed the payment for the NCA as payment of the shares – minister argued it was income from an independent source.

Held Non-compete payments received under a restrictive covenant undertaken on the sale of a business did not constitute

income from a source. There were not included as income in this case per s. 3(a) because payments for covenants were specifically dealt with

under s. 42 and this was not covered there. Including under general words of s. 3(a) would amount to an implicit overruling of s. 42 limits

Manrell v the QueenFacts

Manrell was ¼ shareholders who sold shares in companies that produce plastic bottles and caps Sellers entered into non-competition agreement

Payment for noncompetition was approx. $4 million. Manrell argued that property should be given its common law meaning under which his right to compete was not property

so he had not disposed of property giving rise to capital gains. Held

Since property under s. 248(1) of the Act was defined as “property of any kind whatsoever…”. The meaning of “property” was not limited to the common law meaning

S. 248(1) means property of any kind whatsoever – brings within the statutory definition everything that is within the broadest ordinary meaning of the word “property” – nothing in that stat. definition requires a non-exclusive, commonly held right to carry on a business to be treated as “property” for income tax purposes.

Taxable as capital gains. SURROGATUM PRINCIPLE

DEFINITION The surrogatum principle states that a “|person who suffers harm caused by another may seek compensation (a) for loss of income; (b) expenses incurred; (c) property destroyed; (d) personal injury and punitive damages

The nature of the injury or ham will determine the tax consequences of the damagesTEST 1. What was the payment intended to replace?

2. Would the replaced amount have been taxable in the recipients hands?If so – then it is included as income

CASE LAWLondon and Thames Haven Oil Wharves Ltd v AttwoollHeld

Lord Diplock spoke of compensation for a lost source of income as being income I.e. the compensation is a surrogate (substitute) for the lost income from the sale of goods

Tsiaprailis [2005]Facts

Taxpayer injured in a car accident. As a result, she received disability payments under employer’s disability insurance policy.

Insurer initially made payments (1985 – 1993) but then stopped alleging Tsiapralis was not entitled to them. Tsiapralis sued.

Eventually the insurer entered into a settlement paying a lumps um of $105,000 – this included:(i) Amount to compensate for previous payments the insurer had not made(ii) Amount to compensate for future payments that insurer might have been obliged to make in future years; and(iii) Amount to cover her legal costs, disbursements and GST

Generally: compensation for loss of income is taxed as income – and payment for loss of capital is treated on account of capitalTEST FOR CHARACTERISTICS OF INCOME FROM A SOURCE

1. Decision: Was the payment unusual and unexpected – not the kind that oen could set out to earn as income?2. Criteria to look at: the court in Cranswick set out a nonexhaustive list of criteria for assessing whether the receipt of

income constitutes income from a source and is thus taxable: The taxpayer has no enforceable claim to the payment There was no organized effort on the part of the taxpayer to receive payment The payment was not sought after or solicited by the taxpayer in any manner The payment was not expected by the taxpayer either specifically (i.e. in specific circumstances) or customarily

(people would not normally expect this in similar circumstances) The payment had no foreseeable element of recurrence The payor was not a customary source of income to the taxpayer The payment was not in consideration for or in recognition of property, services or anything else provided or to be

provided by the taxpayer, or was not earned by the taxpayer either as a result of any activity or pursuit of gain carried on by the taxpayer

In the case of business or property there is a pursuit of profIt (Stewart) Productive source (Bellingham) – a source capable of producing income

CASE LAW ON CHARATERISTICS OF INCOMEBellingham v R [1996]

Facts Taxpayer’s land expropriated by the Town. Town makes expropriation offer which is challenged by taxpayer. The challenge

is made to the Land Compensation Board. The Board makes an award of almost six times what the town offered. Subsequent litigation over award by the Board resulted in taxpayer accepting settlement offer by town.

Held Proceeds of disposition are income The interest given, arising form the legislation that required such interest to be charged to discourage town from behaviour

of giving a clearly lower award of compensation than it should have, it tantamount to punitive damages. It is NOT income under s. 9(1) nor is it income under s. 3(a)

Ratio:Income stems from a “productive source” (a source capable of producing income) and a punitive damage award is not a productive source. Stewart v The Queen (2002)Principle:Source is not defined and so it is left to the courts to determine the nature and scope of various sources of income in the Act

It is a source if there is a pursuit of profitRELUCTANCE BY THE COURT

While the possibility of unenumerated sources has been acknowledge – in the Schwartz decision – courts are reluctant to extend sources beyond those specifically listed in the Act. This may be because the ITA provides no rules or guidance for calcuing income from such sources. They have stated that

(a) Damages for breach of an employment K prior to work starting is NOT from a source (Shwartz)(b) A non competition agreement is not income from a source (Fortino)(c) Strike pay is not income from a source (Fries)

Ask yourself – does the surrogatum principle apply?WINDFALLS

While windfalls would increase the ability to pay – they are not taxed. They are something that is unexpected, unplanned and not recurring in nature.

It could be income from a source – if there is an organized activity that could lead to an expectation of getting a net gain from the activity.

Consider Cranswick testGIFTS AND INHERITANCES

While the carter commission wanted them to be taxed – because it relates to ones ability to pay and higher income individuals tend to receive a greater portion of gifts and inheritances – they are not taxed

Gifts received in the course of business are benefits and may be taxable ** see belowILLEGAL INCOME

Illegal Income IS TAXABLE as an accretion to wealth; unless the proceeds are seized during an investigation. The Queen v Poynton Facts:

The taxpayer was a director and secretary-treasurer of a contracting company and in charge of the company’s financial operations

Fraudulently obtained 21,000 of company funds by having subcontractors submit invoices for fictitious work and also of the company to be invoiced for work don on his own home

He did not report the fraudulently obtained income on his ta returns for 1966 and ‘67Held

The amounts were “income” under the act The amounts came to him “in respect of, or by virtue of, his office or employment” It was a material acquisition that conferred an economic benefit on him and it came to him by virtue of his position with

the companyEldridge Facts: Ran a call-girl businessHeld: held to be income from business

Buckman v CanadaFacts:

Solicitor used money in client trust accounts for his own use Solicitor paid interest to the clients The minister treated the misappropriated trust funds as income form business and allowed solicitor to deduct the interest

payments to client Trustee said that they shouldn’t be treated as income from business and therefore tax should not have been paid on these

amountsHeld

Derived from income – thus taxable It was to be included as income because it was derived by the solicitor through his business.

DAMAGES SETTLEMENTS AND THE SURROGATUM PRINCIPLE Surrogatum: tax damages and settlements are intended to replace something. Tax them in the same manner as you would the thing they are replacing. (London & Thames) SEE ABOVE FOR FURTHER EXPLANATION

CONTRACTUAL DAMAGES Expectation damages: where damages for lost income are awarded, tax damages as income.

o Exception: where a breach of contract has resulted in the loss of the whole business (e.g. breach of franchise license), that is compensation for the loss of the source; a capital gain.

Reliance damages: this is not an accretion to wealth (just replacing wealth) – not taxed.o Exception: if the amount is to compensate for the loss of property (e.g. a destruction of a building), it will be taxed

as a disposition of property, and thus a capital gain. Restitution damages: like reliance damages, not taxed – just compensation for loss.

PERSONAL INJURY Usually have no source. You are being compensated for the loss of physical ability or the infringement of the right not to be

injured. Really non-contractual restitutionary damages. (Schwartz) Cost of care: not taxed (no accretion to wealth). Compensation for lost earning capacity: (Tsiaprailis)

o Post-judgment damages: not taxable. Replacing a source, to be invested. Tax on interest.o Post-injury, pre-judgment lost income: also not taxable.

Punitive damages: like a windfall, not taxed. Victim’s gain is only incidental to the policy decision to penalize the wrongdoer. (Bellingham)

COMPUTATION OF INCOME Income is determined by totaling all of the amounts from each source. (3(a)) Income from sources is included in income and must be (a) calculated source-by-source, and (b) territorially (province-by-

province and country-by-country). (3(a), 4) Net taxable capital gains are included n income (but are calculated under a different scheme, presented in Part I, Division

B, subdivision c). (3(b)) Policy-based deductions: deductions under subdivision e are allowed (e.g. RRSP, s.60, moving expenses, s.62, partial child

care expenses, s.63). (3(c), 60, 62, 63) Loss recognition: current year losses from enumerated sources can be deducted. (3(d))

o If the amount produced under 3(d) is negative, income is deemed to be 0. (3(f)) The amount calculated by 3(d) or 3(f) is a person’s net income. (3(e))

Capital Gains: Act treats capital gains separately since they do involve not income from a source but the disposition of a source. Other Types of Income: The ITA also adds other types of income that Parliament has decided to tax that might not be generated

from a “source” and thus might not fall in s. 3(a).

INCOME FROM OFFICE AND EMPLOYMENT: EMPLOYEE or INDEPENDENT CONTRACTOR?

INCOME FROM EMPLOYMENT: TIMINGISSUE The issue turns to when the income from employment should be includedRULE S. 5(1) of the ITA says that income from office or employment must be “received by the taxpayer in the year.”

Sections 6 and 7 provide that benefits are to be included in income when receivxxed, and s. 8 allows deductions to be claimed when paid; thus provides a “cash basis” for employment income.

Further support for a cash basis for employment income is found in the decision of Vegso, which notes the significant tax consequences that the timing of receipt can have.

CASE LAW In VegsoFACTS: dad employed daughter to work on his tobacco farm for $8000 per hear but entitled to be paid only $100/yr & balance when she married; daughter married and got $8,282 of employment income at that time; HELD: income from employment is taxable in year of receipt, not years in which it had been earnedNB: result harsh since $800/yr would attract no tax; diff result if she could demand payment (deemed receipt

RECEIPT Items mailed: s. 248(7) items mailed (ex. paycheck) are deemed to have been received on the day they are mailed

Income earned in Y1 but paid in Y2 is received in Y2 (ex. if paid on the 15th of every month, salary for Dec 16, 2012 – Jan 15, 2013 is paid on Jan 15, 2013 and considered 2013 income); true even for retroactive increases in pay (included in year of receipt)

Advance of income: if payment made on Dec 15, 2012 for work to be done from Dec 16, 2012 – Jan 15, 2013, included in 2012 (year 1)

Contrast with income from business: businesses on accrual system, therefore record when income earned not received (matching principle)

Long delay of payment: creates an opportunity to defer tax if the employer deducts payroll expense as the employee earns income, but if employee is not paid for a long time (ex. 2 years) since they don’t include the incTTome until it’s paid. This is dealt with by s. 78(4) of the act that requires remuneration deducted by employer but unpaid for 180 days (6ish months) after year-end must be added back to employer’s income.

Constructive receipt: where an employee asks his or her employer to pay a third party who the employee owes money to or wants to benefit, the income is regarded as constructively received.

CASE LAW In Jean Paul Morin v the QueenFACTS: says he didn’t receive a ~$16,000 from employer since employer deducted $2,000 in taxesHELD: not necessary for employee to “actually touch or feel it, or have it in his bank account”; “‘receive’ means to get or derive benefit from something, to enjoy its advantages without necessarily having it in one’s hands”In Markman v MNRFACTS: taxpayer awarded back pay effective April 1, 1985 but not paid until Jan 2, 1986 (despite intention of employer to pay it sooner); taxpayer wanted to include it in 1985 tax return alleging constructive receiptHELD: constructive receipt “applies only when a payment has been made by a payor to a party who is not the payee, but was made for the benefit of the payee in satisfaction of an obligation contracted by him”In Blenkarn v MNRFACTS: employee was paid a portion of 1960 wages in 1961 but payment available in 1960 and employee voluntarily chose not to requisition a cheque to which he was entitledHELD: payment was received as soon as he had an unconditional right to be paid (unconditional right to be paid different than that income was earned)

INCOME FROM EMPLOYMENT: INCLUSIONS (SS. 5 and 6)ISSUE If ___ were found to be earning income from employment then one would have to apply the rules from ss. 5

through 8 to determine his/her income from employment. RULES S.5(1) provides that income from employment is the “salary, wages, and other remuneration including gratuities”

received by the taxpayer in the year. S. 6(1) brings in other types of remuneration as income from employment “for greater certainty”

S. 6(1)(a) benefits in respect of employment S. 6(1)(b) amounts received by the taxpayer for personal or living expenses or other purposes S. 6(1)(c) directors fees or other fees… in respect of employment Amounts that cover for losses to income from office or employment pursuant to a sickness or accident

s. 6(3) also brings in signing bonuses and non-compete payments to employeesSalary

RULES Given that s. 5 of the ITA provides that the taxpayer’s income for a taxation year from an office or employment is the salary, wages or other remuneration…received by the taxpayer, the salary/wage/etc in the amount of ______ would be included in income from employment.

BenefitsISSUE 1. What Constitutes a benefit

2. Whether the item is convertible into money3. Whether a benefit is actually conferred on an employee, and in particular, whether the amount is an

allowance or a reimbursement of an expense. RULE Once one has determine that a benefit is to be included because (i) it provides a benefit to the employee; (ii) it is in

respect of employment, then one must determine the value of the benefit because s. 6(1) calls for inclusion of the “value” received.

ISSUE #1: Is there a benefit? S. 6(1)(a) sets out the meaning of a benefit – it requires the taxpayer to include in income from

employment “the value of board, lodging and other benefits of any kind whatever received or enjoyed by the taxpayer in the year in respect of, in the course of, or by virtue of an office or employment”

According to the Savage case, a “benefit” is a ‘material acquisition which confers an economic benefit on the taxpayer.” Thus, as a general rule, any material acquisition in respect of employment which confers an economic benefit on a taxpayer falls with paragraph s. 6(1)(a)

CASE LAW #1 In Savage, the word benefit in the context of subsection 6(1) means an economic advantage of material acquisition and the term “benefit of any kind whatever” is quite broad. In general, whether a benefit is taxable under s. 6(1)(a) depends on the underlying nature of the expense covered by the benefit; where the benefit is in nature a personal or living expense – the benefit should be taxable; if the nature of the expense incurred is in the course of carrying out employment duties, then the benefit should not be taxable. In McGoldrick, the principle from this case was that where something was provided to an employee primarily for the benefit of the employer, it will NOT be a taxable benefit if any personal enjoyment was merely incidental to the business purpose. In Waffle the court held that benefits that are not convertible into money may be included. This is based on the wording in s. 6(1)(a) ``value of board, lodging and other benefits of any kind whatever.``(Name) received (item), which conferred a material benefit (since he did not have to pay for these items, he took advantage of both and they were beneficial to him.

Huffman v. The Queen [1990] 2 CTC 132, 90 D.T.C. 6405 (FCA)Facts:

• plainclothes policeman needed special large-fitting clothes to cover gun holster and billy stick• clothes were subject to heavy wear and tear form gun holster• $400 allocated for – employees had to account for it with receipts• during the year amount as increased to $500 but employees just had to account for $400• Minister argued difference between amount actually accounted for (about $421) and the $500 allowed was an allowance

per s. 6(1)(b) of the Act and thus should be included in income• but taxpayer provided evidence he had spent more than $500 in the year on the clothing• also, taxpayer argued that the clothes could not be put to personal use since they were too loose fitting and due to wear

and tear on the clothesHeld: court did not require taxpayer to include the amount in income

Commentary: Here it might be argued the clothes were a material acquisition (so to speak!), but there was no economic benefit to employee since he could not make personal use of the clothesMcGoldrick v. R. (2004), [2004] 3 C.T.C. 264, 2004 D.T.C. 6047 (F.C.A.)Facts:

• employee of casino received one free meal per shift at staff cafeteria (not permitted to bring own food onto employer’s premises, location of casino made it impractical to eat offsite and employees not allowed to leave employer’s premises during shifts without permission – only alternative to cafeteria was vending machines)

• employer also provided employees with tickets to entertainment events and free hams and turkeys on holidays• employer reported these things on employees’ T4’s as taxable benefits (determined as total cost to employer of providing

the benefits divided by the number of employees (over 2,000) for an average cost of about $4.50 per day or just under $1,000 for the year)

• Minister included amounts in income from employment• taxpayer says he did not enjoy eating at the cafeteria

Held:(1) the free meals were a material acquisition that conferred an economic benefit. The fact that the employee did not enjoy

eating at the cafeteria was not determinative. (2) while free meals were primarily for the benefit of employer, there was a personal element that was not just merely

incidental the the benefit to employer Principle: where something is provided to an employee primarily for the benefit of the employer, it will not be a taxable benefit if any personal enjoyment is merely incidental to the business purpose. Waffle v. M.N.R. [1968] C.T.C. 572, 69 D.T.C. 5007 (Ex.Ct.)Facts:

• Waffle was employee of a Ford automobile dealership• as a reward for his sales performance he was given a free Caribbean Cruise not by his employer but by Ford Motor Co. (i.e.,

by a third party)• Waffle could not assign the right to go on the cruise and could not, in any way, convert it into cash• he either took the cruise and got the benefit or he got no benefit at all

Held: Tennant v Smith principle did not apply to s. 6(1)(a) of iTA. S. 6(1)(a) refers to the ‘value of board, lodging and other benefits of any kind whatever” Principle: the wording of s. 6(1)(a) “value of board, lodging and other benefits of any kind whatever” overrides the rule of Tennant v Smith and thus benefits that are not convertible into money may be included. ISSUE #2: Is the benefit in respect of employment?RULE The court in Savage, notes that when assessing whether the benefit was provided to the taxpayer in respect of

employment, the words “in respect of” in s. 6(1)(a) have the “broadest possible meaning in terms of connecting the benefit to the employment”. This effectively creates a presumption that a payment by an employer is in respect of employment.

The court in Waffle indicates that the meaning of “in respect of employment” is broad enough that it includes benefits to employees by third parties.

This presumption may be rebutted; if the employee can show that the benefit was of a personal nature. REBUT THE PRESUMPTION

In rebutting the presumption: Aspects of case law are still relevant, such as the finding in Laidler v Perry that “one looks to the intentions of the employer and whether the benefit could be said to be a mere

personal gift not inspired by the hope of some future quid pro quo” (Laidler) “whether or not the benefit was provided by way of remuneration for services” (Seymour v Reed)

THE TEST (SAVAGE)

The court in Savage accepted a test that asked(i) one should look to whether the benefit provided to a taxpayer serves to benefit as an employee or as a person (ie. A gift given by the boss to an employee as a wedding gift is arguable not a benefit to the employee in respect of employment but is a gift arising out a personal relationship)(ii) it did not accept the case law that benefits be provided by way of remuneration for services(iii) the words in respect of are given their broadest possible meaning in terms of connecting the benefit to the employment

APPLY Factors to Consider: Part of original employment contract? Intentions? Mere personal gift or inspired by the hope of some future quid pro quo? Provided by way of remuneration of services? A personal gift based on a longstanding personal relationship? Given in the context of Xmas/wedding/birthday, or recognition of long service? Gifts the notion of the “broadest possible meaning? However, the ______ provided to _______ did not provide a benefit because he/she could not make

personal use of them. This is comparable to Hoffman.ISSUE #3 How is the benefit valued?RULE Now that we have determined than the employer has provided something that is arguably “a material acquisition

which confers an economic benefit on the taxpayer”, so that is understood as a benefit, we must now determine what an employee could “get for the item in the market”, ie. What did it add to the employee’s economic power.

A starting point is the cost to the employer. This often represents the fair market value but is not determinative

Steen v R defined fair market value as that which a willing buy would pay a willing seller in an open market. The Test for Fair Market Value; is the price that would be willingly paid by a buyer who does not have to buy to a seller who does not have to sell – This test is based on a hypothetical market

Wilkins v Rogerson; says that the value may be determined by the employee for - the amount that can be obtained by selling it

CASE LAW Wilkins V Rogerson – the value of the benefit was its disposable value to the employee (what they can sell it for)

In Giffen v R, the court valued the frequent flyer points obtained as a benefit by an employee for travel he undertook for his employer as equal to the cost of the most restrictive economy fare.

In Rachflowski v R the court found that the value of the benefit (for a free golf membership) should be determined on the basis of actual use rather than availability of the benefit.

APPORTIONMENTRULE There are times when a payment by an employer to, or for the benefit of an employee, has a dual character: (1) it

covers expenses incurred partly for the employer; and (2) it is partly for the personal benefit of the employee. It is difficult to ascertain the taxable value of the employee. The proportion is based on the facts of the case

The courts may apportion the value of the benefit to the extent it was actually used They are more willing to apportion a benefits value where there is good evidence to do so.

CASE LAW In Adler v R, FMV of a parking pass provided the employer with a taxable benefit. However, the court DECLINED to apportion for reasons of administrative simplicity.

McGoldrick v R – the court reduced the assessment by 50% as the taxpayer claimed he ate in the cafeteria only half the time available – he was not able to bring food or get food anywhere else.

In Zakoor v MNR – an apportion of the capital cost of the car was included in income for the employee, even though the car was used for the employers purpose for most of the time – because the car was considered to be luxurious ie. It was more than what was needed for the purposes.

ALLOWANCESISSUE Whether a particular amount (money) paid by (employer) is an allowance and whether the allowance must be

included in income from employmentRULE Allowance is not defined in the Act but there are case law and discussions by the CRA on the topic

S 6(1)(b) includes allowances in income except for some specific exceptions listed under s. 6(1)(B). s 6(1)(B) provides the taxpayer must include in income all amounts received by the taxpayer as an allowance for personal or living expenses, or as an allowance for any other purpose.

Allowance is not defined in the Act but the CRA follows the case law, and defines an allowance as an periodic or other payment that an employee receives from an employer, in addition to salary or wags, without having to account for its use.

In Queen v Pascoe allowance was defined as a limited predetermined sum of money paid to enable the recipient to provide for certain kinds of expense, its amount is determined in advance, and once paid it has the complete discretion of the recipient who is not required to account for it

Allowance v Reimbursement: in Pascoe the court found that a payment in satisfaction of an obligation to indemnify or reimburse someone or to defray his or her actual expense is NOT AN ALLOWANCE.

The KEY QUESTION is whether the recipient has sufficient discretion as to how to spent it, if it only defray his or her actual expenses incurred on behalf of the employer – it is arguably NOT an allowance.

APPLY 1. Does the employee have to accounts for it’s use? (submit receipts)2. If no – then arguably there is discretion – does it fall within one of the permitted exceptions in s. 6(1)(b)?

o Allowance fixed by an Act of Parl or the Treasury Boardo Travel and separation allowances received by members of the Cdn forceso *reasonable allowances for travel expenses paid to an employee who is employed to sell

property or negotiate contracts for the employer [s. 6(1)(b)(v)]o *reasonable allowances for travel expenses paid to an employee where the employee is

required to travel away from the municipality where the employer’s establishment is located [s. 6(1)(b)(vii)]

o * reasonable allowances for the use of automobiles for travelling in the performance of the duties of an office or employment within the municipality [s. 6(1)(b)(vii.1)] ex. nurse of NS (hospital gave her $ to account for travel)

REIMBURSUREMENTS DISTINGUISHEDReimbursements of employer expenses are not taxed because they did not provide a benefit to employee (ex. Buy office supplies for employer). Reimbursements of employee’s personal/living expenses are taxed (ex. If employer pays for gas used in a car driven by employee solely for personal use then amount included in income because it is a benefit to the employee)

An accountable advance is not included in income; it’s an amount paid in advance to an employee who is required to use it to pay for something for the employer, to account for its use and return any amount spent.

INCOME FROM EMPLOYMENT: DEDUCTIONS (S. 8)ISSUE Whether (name) is entitled to any statutory deductions from the income from employment. RULE S. 8(2) limits deduction from employment to those specifically provided for in s. 8(1) : except as permitted

by this section, no deductions shall be made in computing a taxpayers income for a taxation year from an office or employment

S.67 says that the deductions must be reasonable. Deductions from employment income are tightly controlled for the purposes of the ITA.

S. 8 ALLOWANCES

One must look through to s. 8 to determine if the deduction is specifically allowed:

1. TRAVEL EXPENSESS. 8(1)(H) This allows a deduction where the taxpayer was (i) was ordinarly required to carry on the duties of the office or

employment away from the employer’s place of business; and (ii) was required under the contract of employment ot pay the travel expenses incurred by the taxpayer in the performance of the duties of the office or employment

This amounts to the expense by the taxpayer (other than motor vehicle expenses – which have their own rules ) while travelling in the course of employment

A deduction is NOT allowed where the taxpayer received an allowance for travel expenses that was not included in income under s. 6(1)(b)

s. 8(4) and s. 67.1

Meal Expenses While Travelling: S. 8(4) provides that an employee cannot deduct a meal expense UNLESS the employee was required by

the employer to be way from the municipality where employer’s business is located for a period of no less than 12 hours

S. 67.1: the cost for the meal must be reasonable and only can only deduct one-half of the cost of the meal

s. 8(1)(h.1) Motor Vehicle Expenses: has the same two requirements as travel expenses discussed above – it DOES NOT cover expenses incurred to get to your place of employment and then back home.

CASE LAW In Delancy : a football player stayed in hotels during home games – the court held that he could not deduct hotel expenses for home games under s. 8(1)(h) because he was not REQUIRED to travel away from the employer’s place of business for HOME games

In Hogg – court did not allow the deduction of driving to work – it s. 8(1)(h) only applies when you travel AWAY from employer’s place of business – not when you travel to the place where you carry on your duties.

2. LEGAL EXEPNSESs. 8(1)(b) This allows deductions of amounts paid in the year for legal expenses incurred to collect or establish a right to

salary wages owed by the employer or former employer.CASE LAW In Foo the FCA allowed the deduction of the DOJ lawsuit, as he was trying to establish that he was owed

more than he was paid – thus he was establishing a right to a salary – not arguing for an right to a promotion

In Blackburn it was held that legal fees ware deductible when you are collecting wages from improper suspension of salary – was convicted at trial and suspended from job. The legal gees for overturn of the conviction were allowed – to collect wages.

3. OTHER Union and professional dues (s. 8(1)(i)) EI and CPP contributions (s. 8(1)(l.1) Contributions to registered pension plan (s. 8(1)(m)) Supplies (s. 8(1)(i)(iii)) Office rent or salary to an assistant (s. 8(1)(i)(ii)) Sales personnel paid by commission. Capital cost of an auto supplied by the employee used in employer’s business (s. 8(1)(j)) Home office (s. 8(3))

APPLY

INCOME FROM BUSINESS OR PROPERTY: PROFITISSUE It must be determined whether _____ ‘s endeavor involves a “business or property”RULE Income from business is calculated under ss. 9 through 37 of the ACT. The starting point is s. 9(1) which

states that a taxpayer’s income for a taxation year from a business or property is the taxpayer’s profit from that business or property.

Profit is not defined in the Act, but the SCC in Symes has held that profit is a net concept involving revenues less expenses. Therefore, the revenues of a business are included in income from business. Whether something constitutes a profit is a question of law.

In Ikea the court held that an amount is included in income from business where it has the quality of income and where the taxpayer’s right to the amount is “absolute and under no restrictions, K or otherwise, as to its disposition, use of enjoyment”

STAT DEFINITIONS

ITA s. 248(1): business includes a profession, calling, trade, manufacture or undertaking of any kind whatever and … an adventure or concern in the nature of trade but does not include an office or employment”. The definition is not exhaustive, therefore one must look more generally to the ordinary meaning of the word.

ITA s. 248(1) property means property of any kind whatever, whether real or personal or corporeal or incorporeal and without restricting the generality includes: (a) a right of any kind whatever, a share or chose in action; (b) unless a contrary intention is evident, money

COMMON LAW DEFINITIONS

Business: The definition was set out in Smith: “anything which occupies the time and attention and labour of a person in pursuit of profit” The TEST for whether an activity involves a “pursuit of profit” was recently developed by SCC in Stewart and Wells.

Prior to Stewart – the test was whether there was a reasonable expectation of profit. THE STEWART TEST FOR PURSUIT OF PROFIT IN BUSINESS/PROPERTY

1. Assess whether the activity is clearly commercial or if it has a personal element. If it is clearly commercial, then it is Business or Property.

2. If there is a personal element then ask, based on the objective evidence, whether there was a predominant intention to profit(i) For Personal element: an activity undertaken predominately for personal hobby, recreation, or other personal

purposes is not a business. (ii) Sub/Obj Intent: It is not enough for taxpayer to simply assert their intention was to make a profit; any alleged

subjective intention must be supported by objective evidence.

The SCC in Stewart accepted the use of the factors from Moldowan as factors to be considered as part of the assessment of objective evidence as a predominant intention to profit

(iii) Moldowan Factors to Consider: (i) The profit and loss experienced in previous years;(ii) The taxpayer’s training;(iii) The taxpayers intended course of action to convert present losses into future profits; and(iv) The capacity of the venture, given its capitalization, to show a profit after deduction of capital cost allowance

(iv) Sipley v R (TCC 1995)(v) Courts also considered amount of time the taxpayer spent on the particular activity

The older reasonable expectation of profit test from Moldowan is not necessary (Stewart); a REOP is only a factor in determining whether there was an intention to make a profit; “profit” includes capital but if motivation is purely to make capital gains then it is not business/property (rather it is CG)

The fact that a taxpayer was motivated by a desire to reduce taxes does not matter where there is not evidence of personal use or benefit in the operation (Walls)

The effect of Stewart/Walls/Ludco [see page 63] is to allow tax shelters. There were proposed amendments to restore the REOP test in 2003; but they never passed

1. PURSUIT OF PERSONAL PLEASURES/HOBBIES (Pre-Stewart Application)CASE LAWLawyer: Landry v Queen

Facts: 71 yr.-old lawyer started law again after not having practiced for 23 yrs; had losses over 15 years; did not keep good records; didn’t have a budget; did not advertise other than listing in telephone directory; did not always

bill clients for services rendered, etc. Held: FCA held, using REOP, that lawyer was not engaged in a business so could not deduct the lossesSCC in Stewart suggested Landry case wrongly decided on basis that there was no personal element (but may have been a personal element – he may have derived some personal satisfaction in acting as a lawyer)

Author: Payette Facts: taxpayer was author of six books – incurred losses on all the booksHeld: under REOP test, he had no REOP and therefore could not deduct the lossesStewart Application Personal element to writing/publishing the books? If no personal element to the writing and publishing of the six books, endeavor would be considered clearly commercial so no need to assess whether the taxpayer had a predominant intention to profit

Car Racer: Cree Facts: full-time employee of data company claimed losses of $11,600 from car racing in 74. Amateur since 68-73 but turned professional in 74; owned a trailer, a van and a racing car and went to national racing events across the country; expert witness on car racing noted appellant was a licenced professional auto-racer but also testified that: “I don’t know why they do it. There are fifty in Canada. They all have to work because they cannot make a living with auto racing.”Held: appellant’s activity before 1974 had no REOP – so loss not deductible

Stewart Application: 1) personal pleasure in auto racing? Appears yes, amateur/ pro distinction. 2) predominant intention of profit? (4 factors)a. Only losses experienced (no predom intent)b. No pro training, but spent 5 years as amateur, which indicates training (predom intent)c. No sign taxpayer intended to convert present losses into future profit (against predom intent)Van, trailer, race car will depreciate quickly; indicates low capacity of venture to make profit; expert evidence

Restaurant: Sirois Facts: taxpayer’s restaurant in ‘76; seats 20; only open four days a week; ‘82 seats increased to 40; ‘83 started opening 6 days a week and increased advertising; ‘83 and ‘84 produced higher revenues; loss prior to ‘84 but in ‘84 the loss was almost eliminatedHeld: no REOP for 81 before expansion of restaurant; situation different in 82 to 84 with expansion of restaurant, increased operating hours and increased advertising; REOP profit in those years (even though he was making some loss)

Metal Work: Knight

Facts: school teacher interested in metal work; acquired machines; built shop on his property (was a machinist, developed software for machines); machines cost $200k; took leave in ‘86-87 from teaching to develop prototype tools for use in connection with computer software – i.e., software to operate machining equipment; said he was developing the “business”Held: in 1986-87 was only engaged in research, experiment and development – had no product to sell, no business to carry on and hence no source of income; his product was not ready for sale; so no REOP so no deduction of losses allowed for those years.

Yacht: Chequer Facts: acquired 48’ cruiser boat; plan was to charter it out on a full-time basis, had another full-time job in 1981-82; claimed net losses in those years from the boat charter business of $31,534 and $24,608.Held: failed to establish a reasonable expectation of profit so couldn’t deduct lossesStewart: likely not business

2. RENTAL PROPERTIES (PRE-STEWART)CASE LAW: There are instances when personal elements arise in the context of rental properties. Ex. Property may be rented to friends or relatives – or rental property is part of a person`s personal residence. Maloney v MNR Facts: taxpayer rented house to his mother at a low rent; rental income was less than sum of mortgage interest,

property taxes and other maintenance expenses on the property losses on rental property claimed against income from other sources Held: no REOP from property; the annual losses were in the nature of gifts and thus were non-deductible consumption expensesIf Stewart were applied: 1) personal element because prop rented to mother? 2) predom intention — seems not to profit given the cost of mortgage interest, property taxes and maintenance expenses

3. GAMBLING AS A REGULAR ACTIVITY(PRE-STEWART)CASE LAW: Gambling may be characterized as a personal hobby or a commercial activity. The line is drawn based on objective factors. Ex. A bookmaking or operating a betting shop would consititute a business activity versus the casual gambler whose activity is a personal hobbyMorden Facts : inveterate gambler who placed bets on outcome of baseball, hockey, football, and card games; made

money. Taxable?Held: Not subject to tax –mere windfall gains

Walker Facts: farmer was part-owner of several horses; moved in the racing milieu and thereby gained access to info

about horse races; regularly attended horse races betting on them substantially and successfully Held: his gambling activity was not merely a hobby but was sufficiently extensive and systematic to constitute a business; test — (really the source question – does the income come from a source (i.e., something capable of producing income)Stewart: 1) Engaged in an organized activity in a systematic way — so predominant intention was to make an income

Luprypa Facts: after divorce in 1989; no longer employed; practiced playing pool every M – F in afternoons to improve skills; every weekday evening, after 11 pm, would play inebriated opponents; would not drink alcohol so he could maintain an advantage; made $16,000 from pool in 1989, $20,000 in 1990 and $40,000 in 1991; won $200 to $300 almost daily (i.e., about $48,090 per year)Held: Luprypa had a system and a reasonable expectation of profit (applying Moldowan case since case was pre-Stewart); it was his principal source of income and he managed risks by being a skilled player, spending afternoons practicing to improve his skills, playing only inebriated players after 11 p.m., and avoiding alcohol himself, Monday – Friday practice Stewart: 1) appears that it was purely commercial

GAMBLING POST STEWARTLeBlanc Facts: 2 brothers had grade 12 education; had worked in father’s window washing business; prior to ‘96 won a

substantial amount of $ on a lottery; in ‘96 they started to invest heavily in sports lotteries (point spread, over & under, etc.); lived cheaply & ploughed winnings back into lottery games; brothers estimated they lost 95% of bets; spent $50 mil over 4 years, but made $55 mill.Held: not organized, not business (MG: error, b/c expert statistician said the odds would have been incredibly small w/o a system)

Cohen Facts: lawyer quit practicing law to play poker full-time; played 6 to 8 hours per day & attended several tournaments out of town; otherwise self-taught; for 2006 taxation year reported loss of $121,992; had law firm income from employment $200,000 in 2005 and continuing to receive law firm severance pay in 2006 expenses included purchases identified as “inventory” (cash spent to get into poker games); interest charges; money spent on books; registration fees for the Las Vegas seminar; and travel expensesHeld: applied Stewart, found not engaged in a business since his training was limited attendance at a single seminar in Las Vegas and the reading of books and articles; no business plan or budget or system for winning

SUMMARY OF GAMBLING:

The test for these cases asks whether the activities are:1. Organized; 2. Sufficiently extensive and systematic – this goes to the question of does the income come from the source – it is something

that is capable of producing income

INCOME FROM BUSINESS OR PROPERTYBUSINESS v PROPERTY For the most party the ITA treat business and property the same. However, there are some exceptions:

1. Attribution Rules (s. 74.1 and 74.2) apply to the transfer of property from Spouse A to B, where income from property or capital is included in the income of Spouse A (prevents splitting)

2. Non-Resident Income from Business Carried on in Canada (s. 2(3)) is taxed at s.117 graduated tax rates, whereas income from property is taxed at a flat rate in Part XIII tax (s. 212)

3. Income from Business Allocated to Provinces of Permanent Establishment (Reg. 2601), whereas income from property taxed in province in which the owner was resident on the last day of the taxation year.

4. Foreign Accrual Property Interest Definition Excludes Active Business Income (s. 95(1)); FAPI rules prevent incorporating an offshore co. to hold foreign investments (accrual in foreign corp must be included in income), so doesn’t apply if the offshore co is carrying on a real business

5. Capital Cost Allowance Restrictions on “Rental Property” (Reg. 1100(11)) do not allow CCA to result in losses from “rental property” (stop loss rules) [but these do not apply to income from business]

6. Cumulative Eligible Capital Deductions only in respect of a Business (s. 20(1)(b)), not for property (applies to intangibles that are income from a business (ex. copyright, goodwill))

7. Small Business Deduction and Investment Income Refund: Distinction made between “active business” income for which small business deduction available (s. 125) and “aggregate investment income” that excludes active business income and for which a partial refund is available (s. 129)

8. Inclusion of amount received for goods not delivered or services not rendered is for a business (s. 12(1)(a); accrual accounting)

The difference between business and property has been held to lie in the level of activity. LEVEL OF ACTIVITY TEST

The test lies in the level of activity – whether the income comes from mere ownership of property (passive. Dividends and normally interest on loans – income from property), or whether income come primarily from efforts of owner or employees (active: requiring time, labour and effort)

RENTAL PROPERTIESPROPERTY If activities are typical of those involved in maintaining property such as : maintenance of the building,

heating, lighting, air condition and parking then rental income will still be considered property incomeBUSINESS at some point addition of services such as : protection, house keeping, laundry, mail service, a restaurant,

etc will cause income to be income from business; where landlord owns many buildings and engages a significant management team to manage the buildings and the business or renting and maintain the buildings – then rental income may be considered business

BANKING BUSINESSPROPERTY Normally interest on a loan would be considered income from propertyBUSINESS If lender is a bank that makes a business of lending, interest income would be considered business income. THERE IS A REBUTTABLE PRESUMPTION THAT CORPORATE ENTITIES EARN INCOME FROM BUSINESS RATHER THAN PROPERTYCanadian Maccaroni Company

FACTS: co had electronic equipment manuf and processing (M&P division) and broadcasting division; sold broadcasting division and senior officer and 12 employees involved (albeit part time) did trading to invest the proceeds (while looking for a permanent investment), claimed M&P deduction on income from the tradingHELD: presumption that a corporation earns its income from business, not property; in this case not rebutted (income from business), could claim M&P deduction (which the ITA said was avail for active business income)

INCOME FROM BUSINESS OR PROPERTY: INCLUSIONSISSUE If ____ were found to be earning income from business, the next is whether ______ (items) would be

included as income from property – realization principleRULE Income from business is calculated under ss. 9 through 37 of the ACT. The starting point is s. 9(1)

which states that a taxpayer’s income for a taxation year from a business or property is the taxpayer’s profit from that business or property. Profit is not defined in the Act, but the SCC in Symes has held that profit is a net concept involving revenues less expenses. Therefore, the revenues of a business are included in income from business. Whether something constitutes a profit is a question of law.

S. 12 – 17 of the ITA sets out rules for inclusion of income from business or property. The general purpose of the inclusion provisions is to reinforce the accrual approach to the recognition of business or property income S. 12: deals with common types of transactions which include (i) the sale of goods, (ii) the

provision of services, (iii) the receipt of interest, (iv) dividends, (v) rent, and (vi) royalties S. 13: provides a system for depreciation (or what the ITA refers to as “capital cost allowance”)

to deal with the expense from the wear and tear on investments in plant and equipment that last longer than one year

S. 14: provides a system for the amortization of capital expenditures on intangible assets such as patents, copy right, or good will (expenditures on these intangible assets are referred to in the Act as “cumulative eligible expenditures”)

Sections 15 to 17 provide some anti-avoidance rulesTEST FOR WHEN AN AMOUNT IS INCLUDED IN INCOME FROM BUSINESS OR PROPERTY

IKEA CASE In IKEA the court held that an amount is included : when it has the quality of income. It has the quality income when:

The taxpayers right to the amount is absolute and under no restrictions, K or otherwise, as to its disposition, use of enjoyment

An amount may be considered income when it is realized according to the accrual accounting, even if it isn`t received. What this means from IKEA – is that amounts received or realized by the taxpayer, free of conditions or restrictions upon their use, are taxable in the year realized subject to any contrary provision of the Act or other rule of Law

APPLY Apply: the amount is due to _____ because ______ has done everything the K required and therefore has an absolute right to the amount ‘with no restrictions, K or otherwise’”`

DETERMINING WHEN AN AMOUNT IS INCLDUED IN COME FROM BUSINESS OR PROPERTY – WHEN IT IS RECEIVABLEGAAP According to GAAP (Generally Accepted Accounting Principles)STAT PROVISIONS S. 12(1)(b) provides that “Any amount receivable by the taxpayer in respect of property sold or

services rendered in the course of a business in the year, notwithstanding that the amount or any part thereof is not due until a subsequent year, …” and “in respect of services rendered in the course of a business” an amount is receivable the earlier of:

(i) the day on which the account in respect of the services was rendered, and(ii) the day on which the account in respect of those services would have been rendered had there been no undue delay in rendering the account in respect of the service.”

If a service is rendered but not yet billed and undue delay has not passed, it may nonetheless be included in income under s. 9(1) where the taxpayer had absolute right but just had not rendered the bill

CASE LAW In Colford the court found that it was not enough that a recipient had a precarious right to receive an amount in question, he must also have a clearly legal, though not necessarily immediate, right to receive it. This is normally when a person

(a) Has completed the services contracted for; or(b) When the goods sold have been delivered.

HOLD BACKSCOLFORD A holdback is where a contractor had completed the work but was not entitled to receive the payment until

certificates of satisfactory completion were issued. A clear legal right to receive it would only arise when the certificate is rendered

EXPROPRIATIONBENABY REALTIES The court found that a clear legal right to receive money for expropriation did not occur at the moment of

expropriation. A legal right may have existed but the right was not clearly to a fixed amount. As soon as it is fixed by agreement, arbitration, or court order, there is a legal right to a known

amount that is receivable. SALE OF PROPERTY

The CRAs position is that the amount is receivable for the sale of goods on the date of exchange; AND where the date of exchange is not specified then it is when incidents of ownership pass to the purchaser.SALE OF GOODS in many cases involving the sale of goods the amount will become receivable at the time of delivery.SALE OF REAL PROPERTY

Date of inclusion would normally be the closing date – this is usually the day on which title to the property passes and payment is made.

SERVICESThe general timing rule is that payments for services are usually receivable when the services have been renderedCASE LAWMARITIME amounts were to be included in income even though services were provided in last month of the

year and had not been paid for by the customers by the end of the year because the services had been rendered and thus Maritime Telegraph had an absolute right to the amounts

Where services are charged for an hourly or daily basis – the amount is to be included in the income, even though the services under the K have not been completed. Ex. Legal servicesWEST KOOTNEY the income was earned in the year that the services was provided – the year the electricity had been

provided – because the taxpayer had done all that as needed to be done in order to have a right to the income

EXCEPTION FOR CERTAIN TYPES OF PROFESSIONAL SERVICESWORK IN PROGRESS Professional services and businesses have work in progress. The rule is that the amount would be receivable

in respect of works in progress, it would be included under the general accrual rule or under s. 12(1)(b) as income

work in progress – is not defined under the ITA but it has been held to be the part of the services rendered which has not yet been invoiced or should not be invoiced – where taxpayers cannot bill the client but services have been partially rendered [see page 74 of outline]

s. 34 allows for lawyers, dentists, veterinarians or chiropractors to elect NOT to include amounts that would be in respect of works in progress. Where a taxpayer elects to use s. 34 they must continue to do so in the future year – unless they change it with the approval of the MNR.

RENT AND ROYALTIESDIVIDENDS S. 248(1) defines dividend to include a stock dividend. Dividends refer to a pro rata distribution from a

corporation to it’s stockholders.RENT AND ROYALTIES Rent from leasing real property is usually included as income from property. However, it may be

income from business when there is something more than just the collection of rent. The terms rent and royalties are not defined in the Act:

s. 12(1)(g) requires the inclusion in income of any amount received by the taxpayer in the year that was dependent on the use of or production from property (ie. Rent and royalties are included on a cash basis)

rent – usually a fixed payment for use over a period of time royalty – usually a payment for the use of an intangible property or a payment for the production or

use of interests in such property as oil, gas or mineralsDEBT AND INTERESTS

ISSUE Whether a particular payment on a loan consists partly of principal and partly of interests and how the payments are to be treated under the ITA.

RULE In debt instruments – residential mortgage payments - payments are part for interest and part for principal over the life of the loan (blended payments).

S. 16(1) provides that where under a contract or other arrangement, an amount can be reasonably regarded as being party interest…and in part an amount of a capital nature – that part shall be deemed to be interest

As a result – the part deemed to be interest is included in income per s 12(1) [or deducted under s. 20(1)(c)]

When receiving blended income you must unblend the payment to determine the part that can be reasonably regarded as interest

Where debt obligations yield interest, the interest is included as incomeCASE LAW FACTS: instead of selling property for $370k (purchaser wouldn’t agree) taxpayer sold a farm for $395k with

$85k payable immediately and $310k was payable in installments over the next six years. No interest was payable by the purchaser; would the $25k (difference between 370 and 395) be considered interest?HELD: payments over the 7 years could reasonably be regarded as payments of part principal/part interest. NOTE: installments can be genuinely interest-free where the taxpayer and the borrower are not at arm’s length (e.g., parent sells property to child), but where parties are at arm’s length, it is hard to see why vendor would accept a low interest or interest-free deferred payment unless the purchaser agreed to pay more than the market price

ISSUE When must a debt obligation be included as income?RULE Yield (benefit to the creditor) on an obligation (like a bond) generally includes the interest paid, but

also the difference between face value paid on maturity and price paid for the bond(i) If the bond is sold to the creditor at a discount, the yield is higher than just the interest(ii) If the bond is sold to the creditor at a premium, the yield is lower than just the interestEx: D issues bond to C for $10,000 with 5% interest per annum – later C sells bonds to P when interest rates have gone up to say 10% for $6,000 – P gets $500 per annum on $6,000 investment for 8.33% return and then gets $10,000 on maturity for a further gain of $4,000

S. 16(1) applies to an original issue discount, and an amount that can reasonably be regarded as interest is taxed as such ($4,000 gain in above example considered interest).

In Satinder v the Queen, the FCA found that with respect to the sale of a debt obligation at a discount, the discount portion was interest income under s. 16(1).

Section 20(1)(f)(i) provides that the discount can be deducted 3%ISSUE When must discounts on a debt obligation be included in income?RULE However, interest need not be included where the discount was not engineered at the outset. In

Wood v MNR, an investor who purchased a mortgage at a substantial discount and held it to maturity did not have to report the redemption proceeds as interest income. The reason was that the discount was not engineered at the outset but resulted from market forces.

o 16(1) doesn’t apply (today would be considered CG)

INCOME FROM BUSINESS OR PROPERTY: DEDUCTIONSISSUE If the income is regarded as income from business or property, it must be determined (1) whether the

expenses are deductible as income from business or property. Sub issues include (2) whether the amount of deductions are reasonable, and (3) when the expenses can be deducted

RULE As noted above, s. 9(1) provides that income from business is profit (revenues less expenses); also profit (according to the Canderel case) is determined according to well-accepted business principles (which include GAAP) subject to the Act and case law. In calculating income from business, GAAP requires that expenses be incurred for the purpose of earning income from business.

INTRODUCTION TO THE KEY QUESTIONSA. Is the expense deductible?

RULE To be deductible the expense must have been incurred for the purpose of (a) earning income from business or property (thus expenses for personal consumption or savings are NOT deductible); (b) expenses are ONLY deductible if they are incurred to earn income from business or property

S. 18(1)(a) disallows or limits certain deductions. Holds that no personal or lving expenses, other than travel can be deducted

o S. 18(1)(b): no deduction in respect of capital expenditures: “an outlay, loss or replacement of capital, a payment on account of capital or an allowance in respect of depreciation, obsolescence or depletion except as expressly permitted by [Part I, s. 20(1)(a) and (b)]

o S. 18(1)(h): no deduction can be made in respect of “personal or living expenses of the taxpayer” (defined in 248(1); ex. food, shelter, clothing, personal entertainment)

o S. 18(9) prohibits deduction of prepaid expenses (deducted in year to which they relate) S . 67 expenses must be reasonable in all circumstances

B. Whether the amount of the expense was reasonable RULE S. 20, by contrasting, permits certain deductions. For example, s. 20(1) permits reserves to be

deducted in the year to which they relate (even if not paid until the future). S. 63 allows partial deductibility of childcare expenses to employment/business (see the

limitations). S. 67 adds a further requirement that expenses are reasonable in the circumstances.

C. When is it deductible?It is important to distinguish between current expenditures – that can usually be deducted in the year of expenditure – and capital expenditures that much be deferred [more on that in the next section]

S. 18(9) prohibits the deduction or prepaid expenses and defers their deduction to the year to which they relate

S. 20(1) permits serves to be taking (allowing deductions for expenses in the year to which they relate but which will not be paid or incurred until a year later

1. DEDUCTIBLE: TEST FOR WHEN AN EXPENSE IS INCURRED FOR THE PURPOSE OF GAINING OR PRODUCING INCOME FROM BUSINESS

SYMES CASE 1. GAAP: Whether the expense is deductible according to accounting principles or practice, such as GAAP

2. OTHER BUSINESSES: Whether the expense is normally incurred by other taxpayers carrying on a similar business. If it is, there may be an increased likelihood that the expense is a business expense

3. BUT FOR: Whether a particular expense would have been incurred if the taxpayer were not engaged in the pursuit of business or property income or whether, in absence of the business activity, the need to incur the expense (food, shelter, clothing, etc) would still be there

4. AVOIDABILITY: Whether the taxpayer could have avoided the expense without affect gross income5. TRADE: Whether the expense is an expense of the trader or of the trade. If the expense was an

incident of the trade – part of the business operation itself – then it is an income earning expense6. CIRCLE: Whether a particular was incurred in order to approach the income producing circle (ex.

Clothing, child care, house keeping, etc) or was it incurred within the circle itself. This test may be of limited assistance in cases where the personal circle and income producing circle overlap, such as in the case of home office expenses

SCOTT CASE Subsequent to Symes the FCA used the following tests to determine whether an expense was for the

purpose of gaining income from business: 1. What is the need that the expense meets;2. Would that need exist apart from the business; and3. Is the need intrinsic to the business? ** questions 2 and 3 are articulated in Symes

DUAL PURPOSE EXPENSESDual Purpose Expenses – is an expense that can be considered to be partly incurred for the purposes of producing income from business or property, and partly considered a personal or living expense.

The personal portion cannot be deducted in determining income from business and propertyApportionment The expense between an income producing portion and a personal or living expends (ex. Meals and

entertainment are always apportioned 50% under s. 67.1) Stapley – s. 67.1 applied to a real estate agent who provided clients with gift certificates for

good/beverage even though he didn’t consume them himself.Principle Purpose Some cases deduct the entire amount if the expense is principally for business or disallowing entirely if the

principle is personal Cormack – doctor who become a professor was not allowed to deduct expenses incurred on a trip

to Europe to study educational methods on the basis that the principle purpose of the trip was personal

DUALL PURPOSE: CHILD CARE DEDUCTIONSPROVISIONS S. 63 of the ITA comprehensively addresses child care

Only the lower income parent can claim a deduction The deduction cannot exceed 2/3 of the earned income of the lower income parent; and The deduction is capped at $7,000 per child under the age of 7 and $4,000 per child between 7 and

16CASE LAW Symes – the SCC found that the childcare expenses of the female lawyer who paid a nanny to care for her 2

children were non deductible as a business expense as they were not incurred as part of the income earning process – rather they only made the taxpayer available for earning income from business.

DUAL PURPOSE: FOOD AND BEVERAGERULE Expenses for food or beverages or the enjoyment of entertainment incurred for a business

purpose can only be ½ deducted under s. 67.1CASE LAW However, in Scott, the FCA allowed a courier to deduct the cost of an extra meal that his 10 hour/150 km

per day job required. The court analogized it to the extra fuel a car would need. DUAL PURPOSE; ENTERTAINMENT EXPENSES

CASE LAW In Royal Trust Company, the taxpayer deducted the expense of its employees’ memberships in social clubs and other community organizations. Evidence indicated that the employees could meet prospective clients, thereby providing a business advantage. The court found that the principal purpose was to earn income—to acquire and keep clients—not to personally benefit its employees. Deduction allowed.

(1) The expenditure doesn’t have to result in the production of income. It just must be permitted by GAAP principles and have the principal purpose of earning income

STAT PROVISION However, s. 18(1)(l) of the Act NOW disallows deductions for club memberships. Club memberships have a personal element to them as employee benefits from them

DUAL PURPOSE: COMMUTINGCommuting is considered a dual purpose in nature – The journey to work is necessary to earn income but it is also partly a consumption of where you live. The courts have taken the approach – that the expenses for commuting are expenses that makes a taxpayer available for work

but are not incurred in the course of business However, once a taxpayer has traveled to work – then any business related travel from the office to another place, other than

home, for the purpose of business is a business expenseCASE LAW In Cumming an anesthetist rendered all his services at a hospital near his home. However, there was no

office available at the hospital and so he did his books/research at a home office used exclusively for work. Court found that the home office was the base from which the practice operated and thus the trips to the hospital and back were not commutes to work but were trips made in the course of his business.

DUAL PURPOSE: HOUSEKEEPINGThe courts treat house keeping similarly to commuting. It frees the taxpayer for work but is also partly a personal consumption

choice. Accordingly, it is generally not deductibleCASE LAW In Benton, the court rejected the argument that but for the housekeeping expense, the taxpayer would not

have been available for other work. In that case, a 62-year old farmer who owned and operated a 480 acre farm hired a housekeeper (he was a semi invalid due to a stroke) and sought to deduct the cost from his farm business. The court found that any contributions of the housekeeper to the income-earning work of the farm were secondary, even though taxpayer needed her to run the farm; only expense deduction was where the housekeepers’ efforts related to the production of farm income

DUAL PURPOSE: HOME OFFICE EXPENSESTAT A home office expense can be deducted under s. 18(12) if the home office is either:

(1) The individual’s principal place of business, or if not the principal place of business; then(2) It must be used on a regular and continuous basis for meeting clients, customers or patients

Principal in s. 18(2)(i) means first in rank or importance and would generally me, in the context of a home office, that the home office was used more than 50% of the time

CASE LAW In Logan v. MNR, a doctor was permitted to deduct a proportion of the home expenses attributable to the room in the home that was used as an office because he established that the office was used exclusively for work-related activities such as medical writing, bookkeeping and meeting with other doctors

However, in Mallouh v. M.N.R., a doctor was denied a deduction for costs of a home office that occupied half of the basement in home since the office was a sort of general study or den in which business-related work was not the exclusive activity.

Deduction is limited to the extent there is income from the business for which the home office is used.DAMAGES AND SIMILAR PAYMENTS

RULES Damages are deductible if they are incurred as part of the operations (or transactions or services) of the business [per Imperial Oil case]

Damages are not deductible if not part of the operations of the business – i.e., if not part of the normal risks of the business [per Imperial Oil case and the Poulin case]

S. 67 also requires that the expense be reasonable (therefore must satisfy the gaining or producing income test or the enduring benefit test and be reasonable)

Courts will not normally disallow deduction of damages on moral or public policy grounds where the damages could be said to be so egregious or repulsive that it was not for the purpose of earning income from business or property [per the Poultry case and McNeill]

KICKBACKS, BRIBES AND OTHER ILLEGAL PAYMENTSRULE S. 67.5 states “no deduction shall be made in respect of an outlay made or expense incurred for the

purpose of …” [list of illegal activities], which includes bribery in general. Policy. Statute overruled OLD CASE United Color & Chemicals Ltd. v. MNR (1992 TCC): a company could

deduct money it had provided to a manager for the purpose of making bribes as an expense because the bribes allowed the company to make money from business.

FINES AND PENALTIESRULE 18(1)(t) provides that interest/penalties imposed under ITA and other Acts are not deductible

67(6) states that “in computing income, no deduction shall be made in respect of any amount that is a fine or penalty (other than a prescribed fine or penalty) imposed under a law of a country or of a political subdivision of a country (including a state, province or territory) by any person or public body that has authority to impose the fine or penalty.”

OLD CASE (1999) (“Poultry Case”): fines were deductible as long as they were incurred for the purpose of earning income from business or property (but noting that it was conceivable that a breach could be so egregious or repulsive that the fine imposed could not be justified as being incurred for the purpose of producing income)

2. REASONABLE?RULE S. 67 provides that an amount otherwise deductible is deductible only to the extent that the outlay or

expense was reasonable in the circumstances This section applies to all deduction – not just income from business or property deductions – however

it most often arises in this context. There are two main types of cases:1. Expense excessive in relation to purpose2. Non-arm’s length management fees

A. Unreasonableness due to excessive ExpenseCASE LAW In No 511 v MNR – the court held sponsoring a baseball team for advertisement was a legitimate

expenditure, but the expense of more than ½ the company’s profits was excessive and unreasonable.

B. Unreasonableness due to non-arms length payment In Mulder, a co controlled by 2 brothers paid salary to themselves plus one brother’s wife. The court

found the salary given to the wife was excessive; reduced it. In Costigane - a dentist had a family trust that operated a financial services business, employing dental

hygenists from his dental practice as employees. The business provided management/ banking/ accounting to Mr. Costigane’s dentistry office. This allowed Mr. Costigane to pay a fee to CFS, which allowed the family trust to distribute the money. HELD fee charged by CFS to Mr. Costigane excessive; reduced.

HOWEVER, In Aessie v R (2004), self-employed CA whose spouse assisted (spouse = employee of Mayday Mgmt Inc); deducted fees for services provided by his spouse. HELD: “deal with Mayday is a common and reasonable business deal that is not unusual or untoward in the business world. It is not appropriate for the Court to interfere in such a transaction.”

C. When is the amount deductible?ISSUE If the amount is deductible and reasonable, another issue is when the amount is deductible. The timing of

the deduction depends upon whether the expense is characterized as currentRULE Once must distinguished between expenses that bring benefits that will in part accrue beyond the

year (or have enduring value –referred to as capital expenses) and those that bring benefits consumed in the year (referred to as current expenses)

CAPITAL EXPENSE STAT PROVISIONS

S. 18(1)(b) provides that capital expenditures CANNOT BE DEDUCTED. The act then sets oS.ur specific rules for the deduction of such expenditures. S. 20(1)(a) provides a deduction for expenditures of depreciable assets (tangible property) referred to as CCA. S. 20(1)(b) provides a special kind of deduction for expenditure on intangible assets (ex. Copyright)

Some capital expenditures don’t fall in either category – they cant be deducted at all if theyre found to be capital

CURRENT EXPENDITURES STAT PROVISIONS

S. 18(1)(a): current expense can only be deducted if it was ‘made or incurred’ by the taxpayer in determining when an expense is made or incurred, the general rule is to follow the accrual

method, which stipulates that an expense is incurred when the taxpayer has a legal obligation to pay the amount even though there is no immediate obligation to pay it

in Burnco Industries the court noted that an obligation to do something which may in the future entail the necessity of paying money is not an expense

CAPITAL EXPENDITURES (OR CURRENT EXPENDITURES)ISSUE If _____ is incurred for the purpose of earning income from business or property, the issue turns on

whether it Is a capital expenditure or current expenditureRULE the act does not defined a capital expenditure. It is generally a cost incurred on property that will

provide a benefit that will last for beyond the year and usually for a substantial period of time s. 18(1)(b) provides that a capital expenditure cannot be deducted in the year that it is incurred.

Instead, the Act sets out specific rules for the deduction of such expenditures over several years. S. 20(1)(a) provides a deduction for depreciable assets S. 20(1)(b) provides a special kind of deduction on intangible assets Capital that doesn’t fall under either category cannot be deducted Several common law tests have been developed to determine whether an expenditure is a capital

expenditure: the enduring benefit test, the recurring expenditures test, the business structure test, and the residual test. The enduring benefit test is the main test and the business structure test is arguably the same as the enduring benefit test.

TEST #1 The ENDURING BENEFIT test is from Helsby and adopted Johns Mansville. The policy behind the test is that if an expenditure is made to produce a benefit to the business

that will last beyond the current taxation year, then it should not be deducted in full in the current year because this would understate the income for the current year.

Test: consider whether the item provides a benefit beyond the year it was acquired; whether it provides “an asset or an advantage for the enduring benefit of a trade”

CASE LAW #1 The effect of the payment to establish a pension fund creates a substantial and lasting advantage of putting the company in a position throughout its business life to secure and retain services of a competent staff

TEST #1A The BUSINESS STRUCTURE v INCOME EARNIGN PROCESS TEST was established Canada Starch; differentiates capital and current expenditures by asking the question:Is the payment made for the establishment or expansion of the business structure that has an enduring benefit (on account of capital); OR is the payment made as ‘part of a money earning process’ (current expense)

CASE LAW #1A See page 88 – 89 of long outlineTEST #3 The RESIDUAL TEST states that where the interpretation of tax statute is unclear and it’s reasonable to find

both a deduction and no deduction for an expense clearly incurred to earn income, choose deduction (Johns Mansville)

TEST #4 The RECURRING EXPENDITURES test was articulated in Ounsworth and Valamrosa, considers a capital expenditure as in incurred once and for all, where as income expenditure is one that recurs every year. In other words, it considers whether the expenditure is one that recurs every year (current) or not likely ot recur (capital)

Where it does not make sense to capitalize a relatively small item that provides an enduring benefit (ex. Stapler); tends to be recurring in as similar amount year to year, expense item in current year for administrative simplicity

TYPES OF CAPITAL ASSETSDepreciable Property [s. 20(1)(a); Reg 1100]

“Depreciable property” defined in s. 248(1) which simply says it “has the meaning assigned by s. 13(2)” s. 13(21) defines “depreciable property” as property for which a deduction can be taken under s. 20(1)(a) depreciable property includes some types of tangible properties and few types of intangible properties (patent, franchise,

concession or license for a limited period – but not minerals, etc.) depreciable property, such as a computer, building, machine, or other tangible asset in which the value wastes away during

a period of time; the cost of which is recognized or recovered under the capital allowance system

Intangibles - Eligible Capital Expenditures [s. 20(1)(b); s. 14] Intangible properties (such as patents, trademarks, and copyright) which are used in earning income from a business (not

property), the cost of which is recognized either under the capital cost allowance system or the “cumulative eligible capital amount” system

s. 20(1)(b) permits a deduction of an amount in respect of most types of intangible properties expenditures of this type are referred to as “eligible capital expenditures” 3/4s of these eligible capital expenditures are added to an account called “cumulative eligible capital” and then a deduction

of 7% of the outstanding balance of the cumulative eligible capital can be deducted every year. S. 14 provides for the rules on the cumulative eligible capital deduction

Non –Depreciable Property [ex. land]Non-depreciable capital property (typically land), the cost of which is recovered only when the property is sold.

there is no deduction under reg. Part XI

Natural Resources s. 65 of the Act deals with the case of natural resources, such as an oil or gas well, mine or timber license. The act allows a

deduction based on the depletion system

“Nothings” [e.g. S. 18(1) recreational facilities] these are a final category of expenditures that are never deductible in computing income or capital gains. They may provide

benefits in the future. o Examples are expenditures that did not result in acquisition of any assets mentioned above, intangible property

acquired to earn income from property, and expenditures that cannot be deducted because of statutory prohibitions.

Ex. expenses for recreational facilities, clubs or yachts cannot be deducted per s. 18(1)SPECIFIC PROBLEM AREAS AND WHETHER THEY ARE A CAPITAL EXPENSE OR CURRENT EXPENSE

REPAIR OF TANGIBLE ASSETS

The test for whether the cost of repair or improvement of an asset is capital or current for the purposes of the ITA begins by considering whether the cost was incurred for business (i.e. not personal). If it was incurred for business, the three-part test assesses: Relative size of the expenditure (if it’s small, less likely capital) Whether the expenditure is recurring (recurring indicates current) Effect of expenditure on the value of the asset repaired (restoring asset to normal operation does

not increase enduring benefit it was originally expected to provide – current – vs extending its life or substantially increasing value of the asset – capital)

CASE LAW D replaces a flat roof with a sloped roof. It was substantial, it wasn’t recurring, and it increased the value of the building. It was thus an enduring benefit. Capital. (Earl)

Replaced walls/floors of ship. Sizeable expenditure, resulted from usual wear and tear (so perhaps recurring?), but didn’t change nature of ship (only restored to original) Current. (Canada Steamship)

D buys building with sinking floor, so D puts in reinforced (better quality) flooring. sizeable, not recurring, restored building to normal operation but improved quality. Capital. (Shabro)

PROTECTION OF INTANGIBLE ASSETS

The problem has arisen with respect to expenses incurred in the defense or protection of title to property. One type of costs is legal costs

CASE LAW Canada Starch: current: payment to a competitor to settle trademark dispute; related to “process” of carrying on business rather than “business entity, structure or org”; didn’t provide “enduring benefit”

o Kellogg: current: cost of litigating right to use name “Shredded Wheat”— perhaps b/c preserving intangible asset (“Shredded Wheat”) is similar to repairing its normal usefulness of an asset. (but non-recurring)

NB: in Starch and Kellogg, courts may have been willing to stretch because otherwise there would have been no deductions even though they were clearly incurred to earn income from business and reduced ability to pay

o Dominion Natural Gas Co: capital (enduring benefit): legal costs to defend challenge to its license to supply natural gas not deductible; costs increased value of licenc e by removing cloud on validity. After litigation the taxpayer had a less vulnerable and more valuable license than before – an enduring benefit

WEBSITES AND DOMAIN NAMES

Corporations and other entities often incur significant costs to develop internet website to promote and sell their products. Many are deducted as current expenses but some are deducted as capital expenses – hardware, etc.

The TEST for trying to characterize expenditures incurred in acquiring domain names for tax purposes is does it have an enduring benefit

CAPITAL EXPENDITURE – where the domain name is well known and is equivalent to a trade mark then it would have an enduring benefit

CURRENT EXPENDITURE – domain name has limited lifeCORPORATE TAKE The enduring benefit test clearly refers to an expenditure that can bring into existence an advantage.

OVER Courts have held that the expense of defending a hostile take over bid is a CAPITAL EXPENDITURE (Neonex)

An expense incurred by a target in a friendly take over has been held to be a CURRENT EXPENDITURE

GOOD WILL Good will is essentially the intangible advantages possessed by an established business: the name, reputation, connections with suppliers etc.

the cots of purchasing good will is a CAPITAL EXPENDITURE (Gifford)EXPENSES WITH RESPECT TO NEW BUSINESSES

Expenses incurred in entering a new business may be characterized as capital expenditures or current expenditures:

CAPITAL COSTS: start up costs, expenditures incurred prior to entering a new business, expenses incurred to change or expand a new business

CURRENT COSTS: costs of earning the income or performing the income-earning operations