August 2019 Newsletter

Under current rules, employee stock option benefits are normally only half taxed. That is, in most cases only half of the benefits are included in the employee’s taxable income. The amount of the benefit equals the amount by which the fair market value of the shares when the option is exercised exceeds the price paid for the shares under the option. (If the employee paid something to acquire the option, that would reduce the amount of the benefit.)

In the 2019 Federal Budget, the government announced that it would be restricting the one-half inclusion rule. The Liberal government felt that the rule was not generally warranted for employees of large, mature corporations. As such, the government proposed that only $200,000 worth of stock option grants annually should qualify for the one-half rule. Benefits above the $200,000 threshold would be fully taxable. However, the Budget papers stated that the restriction would not apply to employees of smaller, start-up corporations.

General rule

The Income Tax Act has a fairly onerous rule that provides that a shareholder of a corporation that receives a loan from the corporation must include the full amount of the loan in income for tax purposes. This rule also applies to a loan received from the corporation by a person “connected” with a shareholder, which generally includes a person who is non-arm’s length with (related to) the shareholder.

Fortunately, there are various exceptions to the rule.

Exceptions to the rule

The rule also does not apply to a shareholder loan that is repaid within one year after the end of the corporation's taxation year in which the loan was made. However, the repayment cannot be part of a series of loans and repayments from and to the corporation. This exception allows you to repay the loan almost two years later, depending on when the loan is made.

There are specific rules that apply to gains and losses from dispositions of personal-use property (PUP). For these purposes, PUP is generally defined as property that is used primarily for personal use by the owner of the property or a related person. PUP includes property such as your personal-use furniture, clothing, jewellery, cars, bicycles, computers, and even your home.

One of the main rules regarding PUP is that a capital loss on the disposition of the property is deemed to be zero (i.e. the loss is denied), unless it is a special category of PUP called “listed personal property" (LPP). Losses from LPP can offset gains from LPP, but not gains from other PUP or other properties.

General Taxation of Dividends

Dividends are taxed preferentially relative to most other sources of income. While the highest marginal federal rate of tax is 33%, the highest rate is 24.81% for “eligible dividends” and 27.57% for “non-eligible dividends”. When provincial taxes are added, a similar discrepancy exists: the combined Federal and provincial rate of tax on ordinary income is higher than that for eligible dividends.

(In general terms, an “eligible dividend” is paid out of a corporation’s business income that is subject to the general (approximately 25%) corporate tax rate. A “non-eligible dividend” is paid out of income that was subject to the small business tax rate for Canadian-controlled private corporations, or investment income that was eligible for a corporate tax refund.)

If you carry on a business, amounts that you receive in advance of providing the goods or services (depending on your business) are included in income, even though they are not yet “earned”. In particular, if you receive an amount in one year on account of goods or services provided in a later year, you must nonetheless include the amount in the year of receipt. A similar rule applies to a landlord who receives advance rent in one year on account of future years.

Fortunately, the Income Tax Act generally allows you a "reserve", to defer the recognition of the amount until the year it is actually “earned” (e.g. when you provide the goods or services). The reserve can be deducted in the year of receipt. It is “added back” to income the following year. If the goods or services are provided in that following year, the add-back is permanent. If the goods or services are not yet provided in that year, the reserve can be claimed again, and the process continues until the goods or services are provided.

Losses from part-time law practice disallowed

In the recent Renaud case, the taxpayer was a lawyer who was employed full-time at a Federal government agency. She also had a part-time law practice of 10 hours a week, from which she ended up losing money every year for many years. She attempted to claim the non-capital losses for tax purposes against her other sources of income. Apparently, her practice consisted of helping clients with low incomes who could not pay her enough for her to make a profit.

The Tax Court of Canada found that Ms. Renaud's practice was not sufficiently commercial, but rather had a significant personal element, and as a result it did not constitute a “source” of income. Her losses were therefore denied.