CHAPTER NINE

1. CHAPTER NINE • Other Income, Other Deductions, and Special Rules for Completing Net Income for Tax Purposes • I. Other Sources of Income • II. Other Deductions • III. Registered Retirement Savings Plans • IV. Special Rules for Net Income Determination

2. I. Other Sources of Income • A catch-all category that captures taxable income which does not qualify as one of the primary sources. • The items classified as other sources of income are all from a specific list found in sections 56 through 59.1 of the Act.

3. The major types of income that are taxable as other sources of income are as follows: • Benefits received from an RRSP • Benefits received from a registered retirement income fund created from an RRSP • Pension benefits received from an employer’s pension plan • OAS, CPP, QPP • DPSP benefits received • Foreign pension benefits • Retiring allowances • EI benefits • RESP income

4. Scholarships, fellowships, or bursaries, to the extent that such payments exceed $3,000 (applies only to amounts received by a student enrolled in a program entitling the student to claim the education tax credit). Otherwise, such receipts, including prizes for achievement in a field of endeavour, are exempt only to the extent of $500 annually. • Research grants received in excess of expenses incurred to conduct the related research activity. • Support payments from a former spouse, provided that they are received as periodic payments and are pursuant to a court order or written agreement.

5. The total of a taxpayer’s other items of income is included in Segment A, along with employment income, business income, and property income.

6. What items are not subject to tax under the Canadian tax system? • Lottery winnings • Receipt of a gift • Receipt of an inheritance • Life insurance proceeds on the death of an individual • Profits from betting or gambling, when conducted for pleasure or enjoyment • Proceeds from accident, disability, sickness, or income maintenance insurance policies (if the employee has paid all of the premiums).

7. II. Other Deductions • A catch-all category that permits the deduction of items that do not qualify under the four primary sources of income. • Deductions in this category must come from a specific list of items found in section 60 through 66.8 of the Act.

8. The major items included in this category are as follows: • RRSP contributions • Support payments to a former spouse, provided that they are paid on a regular, periodic basis and are pursuant to a court order or written agreement. • Amounts paid by a taxpayer as fees or expenses to conduct an objection or appeal in relation to an assessment under the Act. • Moving expenses • Child care expenses

9. Moving Expenses • Deductible moving expenses are those incurred by an individual for relocation to commence a business or employment in another part of Canada, or to attend a university or other post-secondary school, to the extent of income earned in the new location.

10. Deductible moving expenses include: • Travel costs • Transportation and storage of belongings • Temporary board and lodging near the new or old residence (up to 15 days) • Costs of cancelling a lease for the old residence • Selling costs of the old residence • Legal fees and land transfer taxes for the purchase of a new residence if an old residence is sold • Cost of maintaining a vacant former residence for a period of three months to a maximum of $5,000 • Cost of revising legal documents to reflect a change of address, replacing driver’s licences, and obtaining utility connections and disconnections.

11. Moving expenses are eligible for a deduction only if the new residence location is at least 40 kilometres closer to the new work location than the previous residence. • If all or a portion of the expenses cannot be deduction in the year of the move because of insufficient income at the new location, the unclaimed portion can be carried forward and deducted in the following year.

12. Child Care Expenses • Deductible child care expenses include the cost of babysitting, day care, or lodging at a boarding school, for children 16 years of age or less, provided that the expenses were incurred so that the taxpayer could pursue employment, business, or research activities. • Actual child care expenses are deductible only to the extent that they do not exceed $4,000 per child ($7,000 if the child is under seven years of age at year end), or 2/3 of the taxpayer’s earned income for the year. • If more than one person supports a child, the deduction usually must be claimed by the person with the least amount of income for tax purposes.

13. III. Registered Retirement Savings Plans • An RRSP is a private, tax-sheltered retirement program initiated and controlled by the individual taxpayer for his or her exclusive use. • Investments made through an RRSP have a substantially higher return because they permit the investment of pre-tax earnings to generate returns that are not taxed until they are required for personal use.

14. Contribution Limits • If an individual does not belong to an employer’s RPP or DPSP, the annual RRSP contribution limit is equal to 18% of the individual’s prior year’s “earned income,” up to a maximum of $16,500 (for 2005). • When an individual chooses not to contribute the maximum, the unused portion can be carried forward indefinitely and contributed as a deductible contribution in any future year. • When individuals also belong to an employer’s pension plan or DPSP, the RRSP contribution limit is integrated with those plans.

15. “Earned income” includes employment income, rental income, royalty income, alimony and maintenance income, and research grants net of related expenses. This amount must be reduced by negative amounts of a similar nature – business losses, rental losses, and deductible alimony payments.

16. Usually, all contributions that exceed the annual limit are subject to a penalty tax of 1% per month on part of that excess until the overcontribution is removed. • However, an individual is permitted to overcontribute up to $2,000 during his or her lifetime without penalty. • This overcontribution can be carried forward and deducted from income in a future year when sufficient earned income is available.

17. RRSP Investment Opportunities • RRSP funds are restricted to certain types of investments. • The list of qualified investments includes cash deposits in banks or other financial institutions, term deposits, government-insured or guaranteed bonds, bonds and debentures of public corporations, shares of public corporations, mutual finds, and mortgages on real estate. • Investments in foreign securities cannot exceed 30% of the value of all investments in the plan.

18. Retirement Options • Funds accumulated in an RRSP can be paid out in a lump sum or gradually over a period of time in the form of a pension. • In order to receive regular payments from an RRSP, the plan must be formally converted into a pension vehicle. • Life annuity • Guaranteed fixed term annuity • Registered retirement income fund (RRIF)

19. It is mandatory to convert all of the accumulated RRSP funds to a retirement income vehicle by December 31 of the year in which the individual reaches 69 years of age. • Retirement income can begin in the following calendar year. • Failure to convert by age 69 will result in the automatic cancellation of the RRSP at the beginning of the following year, in which case the full amount of the plan will be taxable.

20. Spousal RRSP • An individual can contribute all or any part of his/her contribution limit to the RRSP of a spouse. • The person who makes the contribution is entitled to claim the related tax deduction. • Designating contributions to a spouse’s plan allows the future payout to be included in the spouse’s taxable income rather than that of the contributor. • Any contributions withdrawn from such a plan by the spouse within two taxation years of the contribution year must be included in the contributor’s income.

21. IV. Special Rules for Net Income Determination • Within each of the five sources of income unusual transactions may occur, the treatment of which is not clearly answered by the established general principles. • The Act includes a set of special rules for determining net income; these provide greater certainty when the established general rules are applied in unusual transactions, and also forestall certain tax avoidance schemes.

22. The special rules are grouped together in sections 67 – 81 of the Act. • In some cases these rules are in conflict with the previously established principles; when they are, the special rules take precedence. • The special rules apply to all of the five sources of income.

23. The Reasonableness Test • All items that are deductible from any source of income are only deductible to the extent that the expenditure is considered reasonable in the particular circumstances. • What is reasonable? • In addition to the general reasonableness test, several more specific reasonableness tests apply to various categories of income: • Deduction for meals, beverages, and entertainment expenses limited to 50% of the actual costs. • Limits placed on the deduction of interest, lease costs, and the capital cost of a passenger vehicle.

24. Allocation of Purchase Price for Multiple Assets • A number of different properties may be acquired or sold as a group. • While the total price is obvious, it may be difficult to allocate that price among the various assets included in the transaction. • Conflict may arise between the purchaser and the vendor: • It is in the buyer’s interest to allocate a greater amount to assets that are permitted a faster write-off rate for tax purposes. • It is in the vendor’s interest to reduce the amount of tax on the sale.

25. The special rules permit CRA to allocate or reallocate the total price for both parties, in accordance with the apparent fair market values of individual properties (irrespective of the legal agreement of sale).

26. Transactions with Inadequate Consideration • When taxpayers enter into a transaction with non-arm’s length parties, special rules apply that prevent the elimination or reduction of tax by selling at a price other than fair market value. • Taxpayers are considered not to be dealing at arm’s length if they are related to each other.

27. The following rules apply to taxpayers not dealing at arm’s length: • Property sold for < FMV is deemed to have been sold by the vendor at FMV. The cost to the purchaser remains the actual price paid. • Property sold for > FMV is not adjusted to the vendor, and the selling price constitutes the proceeds of disposition. The cost to the purchaser is deemed to be equal to FMV, not the actual purchase price. • Property transferred by way of a gift is deemed to have been sold at FMV by the person making the gift. The recipient of the gift is deemed, for tax purposes, to have purchased the property at a cost equal to its FMV.

28. The punitive provisions may apply even when the parties have intended to deal at FMV but have erred while estimating that value. • In such cases, the related parties can protect themselves with a covering written agreement which indicates that the established price is a reasonable estimate of FMV and that, if found to be in error, the price charged and paid will be altered accordingly. • Usually, the existence of such an agreement will cause CRA to adjust both sides of the transaction, thereby eliminating the punitive result, which is double taxation.

29. Non-Arm’s Length Defined • When the values placed on financial transactions are not determined by supply and demand, the parties are considered not to be dealing at arm’s length. • The Act deems parties not to be dealing with each other at arm’s length if they are related. • Non-arm’s length transactions can occur between: • An individual and another individual • An individual and a corporation • A corporation and another corporation

30. Transactions between individuals: • For tax purposes, individuals are related to each other if they are direct-line descendents (grandparents, parents, children, grandchildren, etc.) or if they are brothers, sisters, spouses, or in-laws. • Transactions between individuals and corporations: • An individual is related to a corporation is he/she controls the corporation, or is a member of a related group that controls the corporation, or is related to an individual who controls the corporation. • Transactions between corporations: • Two corporations are related if one corporation controls the other corporation, or if both corporations are controlled by the same person, or if one corporation is controlled by one person who is related to the person who controls the other corporation.

31. Even when parties are not related, it is a question of fact whether they are dealing at arm’s length for a particular transaction. • Where there is sufficient cause, CRA can deem two unrelated parties not to be dealing at arm’s length.

32. Property Transferred to a Spouse or Child • Property transferred to a child, whether by gift or sale, is deemed for tax purposes to have been sold at FMV in accordance with the rules described previously. • Property sold or gifted to a spouse is deemed to have been sold and acquired at its cost amount (capital property is deemed to have been sold at its ACB and depreciable property at its UCC). • Alternatively, a taxpayer can choose to recognize a gain on a spousal transfer.

33. Future Income on Property Transferred to a Spouse or Child • Additional special rules govern the treatment of income that may be earned on a property after it has been transferred. • Subsequent income received by the spouse on transferred property must be included in the net income for tax purposes of the original owner for as long as the couple remains married.

34. The attribution rules do not apply if property is transferred to a spouse in a manner equivalent to an arm’s length transfer. • Income on property transferred to a child under the age of 18 is attributed to the parent until the child’s 18th birthday. However, subsequent capital gains or losses are not subject to attribution.

35. Unpaid Remuneration • In order to prevent the undue delay of taxable remuneration payments, the special rules limit the deductibility of unpaid remuneration. • The employer can deduct unpaid remuneration for tax purposes only if it is paid within 180 days of its taxation year. • If payment is delayed beyond that year, the employer can deduct the remuneration in a subsequent year when it is paid.

36. Gain on Settlement of Debt • An individual or a corporation may be in a position to settle an outstanding debt for less than the amount of principal owing. In effect, the debtor achieves a gain from the transaction. • When this type of gain occurs, it is not directly included in taxable income.

37. Instead, it is first applied to reduce any losses that have been carried over from other years, in the following order: • Non-capital losses • Farm losses • Restricted farm losses • Allowable business investment losses • Net capital losses

38. When a taxpayer does not have any of these losses available, the gain is applied to reduce the capital cost or the ACB of the following types of assets, in any order: • Depreciable property • Capital property (non-depreciable) • Cumulative eligible capital • Certain other properties • If all of the forgiven debt is not consumed by applying it to the above items, ¾ of the remaining amount will be included in the taxpayer’s income in that year.

39. Death of a Taxpayer • The tax implications triggered by the death of an individual taxpayer are as follows: • Income from all sources is accrued up to the date of death. • All capital property that was owned by the deceased is deemed to have been sold at fair market value. • Representatives of the deceased (executors) are given control of the assets. After all liabilities have been satisfied, the assets are either sold or transferred to beneficiaries in accordance with the terms of a will.

40. Amounts Not Included in Income • A number of items are given preferential treatment and excluded from income for tax purposes even though they fall within the normal sources of income. • These items are unusual in nature and are specifically listed in section 81 of the Act.