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August 2015 Newsletter

The “associated corporation” rules in the Income Tax Act are relevant mainly for the purposes of limiting certain income tax preferences or benefits that apply to private corporations.

The most significant limitation relates to the small business deduction that applies to active business income of a Canadian-controlled private corporation (CCPC). The small business deduction results in the first $500,000 of a CCPC’s active business income being subject to a much lower rate of tax than applies to other corporations or other income. As a result of the deduction, the lower federal rate of tax is 11% and, depending on the province, the combined federal and provincial rate ranges from about 14% to 19%. The federal small business rate is being lowered further, to 10.5 % in 2016, 10% in 2017, 9.5% in 2018, and 9% in 2019.

We all know the old saying about these two sure things in life. And one sure thing, death, can result in additional income tax, due to the “deemed dispo-sition” rule that applies on death.

Deemed disposition rule

Basically, the rule provides that on your death, you are deemed to have sold each capital property you own for its current fair market value. This is deemed to happen an instant before your death, so the resulting tax is triggered in your final return, not in your estate, although your estate is liable for the tax. (An exception applies for spouses, as discussed below.)

If you own a building that is a rental property or used in your business, a special rule in the Income Tax Act can apply when you sell the building along with the land on which the building is located (of course, in most cases, you will sell both building and land).

The rule applies if you realize a capital gain on the sale of the land and a terminal loss on the sale of the building. Only half of the capital gain is included in income. In contrast, the entire amount of a terminal loss is normally deductible in full. In general terms, a terminal loss on the sale of a building occurs when you sell the building for proceeds that are less than the undepreciated capital cost (UCC) of the building – normally meaning that the building was previously over-depreciated for income tax purposes relative to its actual value.

If you sell capital property, or you sell inventory in the course of your business, and part or all of the sale price is due after year-end, you may be able to claim a reserve to defer recognizing some of the resulting capital gain or profit.

Capital gains reserve

This reserve can apply where you sell property and realize a capital gain. The maximum reserve you can claim in one year is limited to the lower of the following amounts:

  1. The portion of the gain equal to gain x (proceeds due after year / total proceeds) (i.e., you allocate the gain proportionately to the percentage of the sale price you have not yet received); and
  2. In year of sale ⅘ of the gain, in the next year ⅗ of the gain, in the next year ⅖ of the gain, in the next year ⅕ of the gain, and in the 4th year following the year of sale, nil. (In other words, you must recognize at least 20% of the gain every year, even if more than that percentage of the sale price has not been received.)

The prescribed interest rates that apply for the current calendar quarter are as follows:

  • The interest rate charged on overdue taxes, CPP contributions, and EI premiums is 5%, compounded daily.
  • The interest rate paid on late refunds paid by the CRA to corporations (after 30 days) is 1%, compounded daily.
  • The interest rate paid on late refunds paid by the CRA to other taxpayers is 3%, compounded daily.

 The interest rate used to calculate taxable benefits for employees and shareholders from interest‑free and low-interest loans is 1%.

Abil on loan made to 'alter ego' of corporation not allowed

An allowable business investment loss (ABIL) is deductible against all forms of income, as opposed to other allowable capital losses, which are normally deductible only against taxable capital gains. In very general terms, an ABIL includes a loan made by a taxpayer to a Canadian-controlled private corporation (CCPC) that has become an uncollectible debt (certain other criteria apply).

In the recent Barnwell case, the taxpayer lent money to an individual (Austin) to be invested in a travel book business. The business was actually carried on by a corporation owned by Austin. Apparently, the taxpayer believed the loans, although provided to Austin, were made `in favour` of the corporation. Eventually, the business venture collapsed and part of the loans made by the taxpayer became bad debts. The taxpayer claimed an ABIL, arguing that the loans had been made to the individual as an agent or `alter ego` of the corporation, so that they were really made to the corporation rather than Austin. The CRA disagreed and disallowed the ABIL claim.