May 2018 Newsletter

Overview

Readers may recall that, last July, the federal government proposed significant changes to the taxation of passive investment income earned by a Canadian-controlled private corporation ("CCPC"). Changes were subsequently introduced in the February 2018 Federal Budget (as noted in last month’s Tax Letter), but the changes were more modest than the original proposals.

Under current law, a CCPC is subject to an annual tax rate on its investment income of around 50% or slightly more, depending on the province. However, when it pays out dividends to its shareholder(s), the corporation gets a refund out of its "refundable dividend tax on hand" ("RDTOH"), an account which tracks its investment income. After the refund, and taking into account the tax paid by a high income shareholder on the dividends, the overall tax rate on investment income is also about 50%. This means that there is “integration” between the corporate and personal income tax systems, such that income earned personally or through a corporation is ultimately subject to about the same total tax.

Canada’s income tax system uses the individual as a tax unit, rather than a spousal unit or family unit. In other words, each individual in a family is subject to tax on his or her income, because the income is not pooled with other family members.

Our income tax system also employs graduated or progressive tax rates. This means that as your income increases, the marginal tax rate on your income can increase. For example, in 2018 your first $46,605 of taxable income is subject to a 15% federal tax rate, whereas your taxable income exceeding $205,842 is subject to a 33% rate. Taxable income between those thresholds is subject to three other rates (20.5%, 26%, and 29%), again depending on your level of taxable income. On top of that, each province levies progressive provincial income tax and those rates vary depending on the province.

As a result of the individual tax unit and the progressive tax rates, if a high-income individual can shift income to a lower income individual, there will be an overall savings in tax. For example, if you are a parent in the highest tax bracket and you can shift some of your income to your spouse or minor child in a low tax bracket, you will obviously save tax.

If you adopt a minor child (under the age of 18), you will normally qualify for the adoption tax credit.

The federal credit equals 15% of up to $15,000 of your “eligible adoption expenses”. Each province has a similar credit.

For the federal credit, the expenses must be incurred during the “adoption period”, which is generally the period between your application for the adoption and the later of the time of the final adoption order and when the child begins to reside with you.

The Canada Revenue Agency (CRA) recently announced the prescribed interest rates that apply to amounts owed to the CRA and to amounts the CRA owes to individuals and corporations. The rates are subject to change every calendar quarter. These rates are in effect from April 1, 2018 to June  30, 2018. The rates increased by one percentage point for the first time since 2013, and for only the second time since 2009.

“Salary” paid to spouse not deductible in computing employment income

Under the Income Tax Act, an employee is allowed to deduct from his or her employment income salary paid “to an assistant or substitute, the payment of which by the officer or employee was required by the contract of employment”.

In the recent Blott case, the taxpayer was a market dealer with a securities firm, selling and promoting various products provided by the firm. In two taxation years, he purportedly paid $12,000 in “salary” to his wife for various administrative and management services that aided him in his employment duties. He deducted the salary under the above rule, but the CRA denied the deduction.

Upon appeal to the Tax Court of Canada, there were two main issues.