Chapter Six: Taxable Capital Gains and Allowable Capital Losses 101
General Rules 109
What is disposition? 110
What are ‘proceeds of disposition’? 111
What is ‘adjusted cost base’? 113
What are expenses? 115
Reserves for capital property 116
Special Rules 117
Personal Use Property 117
Principal Residence 119
Other Deemed Dispositions 122
Superficial Loss Rules 123
Chapter Seven: Other Income and Deductions 125
Prizes for achievement 125
Support payments 125
Moving Expenses 126
Child-care expenses 127
Chapter Eight: Rules Relating to Computation of Income 128
Limitations on deductions 128
Deemed proceeds 128
Non-arm’s length transactions 128
PART I – INTRODUCTION
Chapter One: Introduction to the Income Tax
Introduction (no reading)
Income tax 4 basic elements: tax unit (every person resident in Canada at any time in the year), tax base (taxable income), accounting period (calendar year), tax rates (below). Also tax credits which reduce tax otherwise payable or provide refunds
Basic charging provision (includes unit, base and period):
An income tax shall be paid, as required by this Act, on the taxable income for each taxation year of every person resident in Canada at any time in the year.
What is a “tax unit”? the person or persons to whom the tax applies
Subs 2(1) = every person resident in Canada at any time in the year need meaning of “person” and “resident in Canada.”
“Person” includes individuals as well as corporations and tax-exempt entities (per def’ns of “person” and “individual” in subs 248(1).
Residence (no reading)
Tax Base: amount to which the rate or rates of tax is applied to determine the amount of tax payable. Includes all rules respecting measurement of income, including exemptions, deductions and inclusions. Per subs 2(1), the tax base is the taxpayer’s “taxable income” for each taxation year.
Taxable income = taxpayer’s income for the year +/- additions and deductions permitted by Division C
s. 3 taxpayer’s income determined by adding amounts referred to in para (a) and those in para (b).
Income = income form all sources inside and outside Canada (including each office, employment, business, and property) [para (a)] + net taxable capital gains from the disposition of property [para (b)].
S. 38 defines “taxable” portion of a capital gain and “allowable” portion of a capital loss as ½ f the gain or loss otherwise determined.
What is “income”? - courts say ordinary meaning
Dictionary def’n: Periodical receipts from one’s business lands, work, investments, etc.
Compare income to capital which is a “stock” of accumulated wealth or value.
Also compare income to gifts and inheritances which, unlike income, are not periodical or recurring.
Caselaw – distinction btwn capital and income has been important
E.g. annuity payments – capital or income?
Shaw v. MNR: taxpayer received monthly payments of $700 under contract of life insurance for which husband had paid total premiums of $37,000. Held: monthly payments are on acct of capital and are not income w/in meaning of Income War Tax Act, 1917.
Note that while annuity payments are now subject to tax, the basic principle that tax applies to income not capital is expressed in Act – b/c Act allows deduction of the capital element of each annuity payment (see para 60(a)).
Act contains rules specifying amounts that may be deducted in computing a taxpayer’s income for a taxation year
Text identifies several types of deductions that may be made:
Para 3(a): Rules which apply to the computation of a taxpayer’s income or loss from a specific source, or to the computation of capital gains or losses. These rules allow for the deduction of costs that must be incurred in order to produce this income.
Para 3(c): Subdivision e of division B of Part I para 3(c) permits deduction of subdivision e deductions except to the extent that they have been “taken into account” in determining the total referred to in paragraph 3(a) by their deduction in computing the taxpayer’s income from one or more of these sources.
Para 3(d): other rules permit deduction of losses against all income, i.e. losses from an office, employment, business or property and allowable business investment losses.
Para 3(b): note that deductions for allowable capital losses are generally restricted to the amount of the taxpayer’s taxable capital gains for the year.
Division C of Part I – deductions in computing taxable income (as opposed to income for tax purposes). E.g. employee stock options, social assistance payments and workers’ compensation, home relocation loan, cumulative lifetime amount wrt capital gains arising on disposition of certain types of property, deduction for northern residents, carried over losses (i.e. from other years)
Policy behind allowing deductions? Various. The accurate measurement of income (gross receipts measure is not accurate – overstates income/financial capacity of taxpayer), incentives for certain types of behaviour (e.g. saving for retirement, engaging in “risky” business ventures – if losses weren’t deductible, people might not take chances in biz)
Problem with deductions – inequitable way to pursue any policy goal other than the accurate measurement of income. WHY? Because under a progressive system, higher-income taxpayers benefit more from a given deduction than do lower-income taxpayers (b/c deductions are made from income taxed at the highest rate). Results in inequitable subsidies. E.g. charitable contributions deductible – taxpayers with marginal rate of 40% get to deduct 40 cents for every dollar of charitable contribution whereas taxpayers with marginal rate of 20% only get to deduct 20 cents for every dollar.
Fed gov’t accepted argument that these deductions constitute inequitable subsidies and response was conversion of deductions into non-refundable credits against total federal tax payable computed at the lowest marginal rate (16%). Critics of this change argue that it was a disguised way of moving the marginal rate schedule upward in order to offset reductions in the “official” tax rates that accompanied these reforms.
While deductions are generally regarded as an inequitable way to pursue policy goals other than the accurate measurement of income, Cdn income tax still permits deductions to encourage specific kinds of behaviour (e.g. saving for retirement)
Exemptions and deductions both reduce amount of taxpayer’s taxable income BUT deductions operate by way of subtraction from income otherwise determined while exemptions are excluded at the outset
Again, text IDs different types of exemptions
Those which apply to computation of TP’s income or loss from a specific source or to computation of taxable capital gains. E.g. para 40(2)(b) exempts gains on the disposition of a TP’s principal residence; para 38(a) exempts ½ of all capital gains by defining the “taxable portion” of capital gains as “1/2 of the TP’s capital gain for the year from the disposition of property.”
Deductions in computing TP’s taxable income
Non-refundable credits in computing TP’s tax payable (SH: how do you have exemptions that are credits or credits that are exemptions?)
E.g. of specific exemptions (book not clear as to what these are exempted from) expense allowances for members of a provincial legislature, compensation paid by Germany to victims of Nazi persecution
Policy considerations underlying these are discussed at p. 59
income tax is paid for each taxation year
def’n per subs 249(1): “fiscal period” in the case of a corporation and a “calendar year” in the case of an individual
subs 11(1): “where an individual is a proprietor of a business, the individual’s income from the business for a taxation year is deemed to be the individual’s income from the business for the fiscal periods of the business that end in that year.”
Old def’n of “fiscal period” allowed corps and individuals w/ business income to select their own accounting period provided it was consistent from one year to the next and did not exceed 12 months.
Implications of this def’n plus 11(1) ability to select off-calendar fiscal period enabled a TP w/ business income to postpone tax on that income by selecting a fiscal period for that business ending in the following calendar year.
This ability to defer income was later eliminated by a legislative amendment which provides that, in the case of individuals and partnerships, no fiscal period may end after the end of the calendar year in which the period began.
What are the implications of a yearly account period? (3)
returns must be filed and taxed paid on an annual basis
Incentive to postpone recognition of income or accelerate recognition of deductions/credits
Relative hardship to taxpayers whose income fluctuates and “bunches” in single years compared with TP whose income is consistent from year to year.
Choice of tax unit, tax base, and accounting period concerns the manner in which the tax burden is distributed among similarly situated taxpayers (horizontal equity)
Selection of rates and rate structures determine the manner in which these burdens are distributed among taxpayers who are differently situated (vertical equity)
In Cda, personal income taxes are applied at graduated or progressive rates above basic exemptions
First $7412 is exempt from tax how does this work? Not included in income all together? Or included in income but just taxed at 0%?
Tax credits are subtracted directly from the amount of tax otherwise payable or credited to the taxpayer as a payment of tax, resulting in a reduction of tax otherwise payable or a tax refund where no tax is otherwise owing
Where credit is subtracted directly – it is called a “non-refundable credit”
Where credit operates as an overpayment of tax, it is a “refundable credit”
A receipt is only considered income and therefore taxable if it comes from a source.
Legislative basis for source concept para 3(a)
Income of a taxpayer is the TP’s income for the year determined by following rules:
(a) determine the total of all amounts each of which is the TP’s income for the year (other than a taxable capital gain from the disposition of a property) from a source inside or outside Canada including each office, employment, business and property.
Source concept ties into distinction btwn capital and income (tree vs. fruit).
Para 3(a) IDs four specific sources – office, employment, business and property. These not exhaustive(can be income from generic source) but Cdn courts have tended to limit sources of taxable receipts to those specifically IDed in the Act. Response of leg various amendments designed to include otherwise excluded income from a particular source (e.g. scholarships – see 56(1)(n) and (o))
[Note that courts’ restrictive interpretation imposed on 3(a) can be attributed to strict construction ambiguities in charging sections of taxing statute resolved in favour of TP]
What is income from source?
Receipt of capital is not income from a source (it is the source)
Distinguish btwn capital (the source) and income produced by the capital (income from a source). If my Dad gives me an apartment building (source), it is a non-taxable receipt, but the income from the apartment building (income from source) is taxable.
Then why are capital gains taxable? Some courts and commentators would say that capital gains are income but this type of income is better understood as income from the disposition of property that may itself constitute a source of income, rather than income from a source itself.
Windfall gains not income from a source (Cranswick, Bellingham)
Bellingham: categories which fall outside of 3(a) gambling gains, gifts and inheritances, windfall gains (residual category).
Bellingham: underlying the source doctrine – understanding that income involves the creation of new wealth. Income must flow from a productive source of income (gifts do not)
Indicia which should be applied when assessing whether a receipt constitutes income from a source (Cranswick; as applied in Bellingham) (*none is conclusive):
Does TP have enforceable claim to payment?
Organized effort on part of TP to receive payment?
Was payment sought after or solicited by TP in any manner?
Was payment expected by TP, either specifically or customarily?
Was payment in consideration for or in recognition of property, services or anything else provided or to be provided by the TP (bargain, exchange, quid pro quo)? Was it earned by the TP, either as a result of any activity or pursuit of gain carried on by TP? [this is important one]
If all of these YES could find that income comes from generic or unidentified source, though courts don’t usually find this
Relevant cases: Fries, Cirella, Goldman, Federal Farms, Frank Beban, Campbell, Manley, H.A. Roberts
Ask: income from employment, business, property, capital gain, generic source?
Bellingham: TP’s land expropriated; received compensation, interest and additional interest (which entitled to per legislation b/c gov’t made low ball offer for his land). Is additional interest income from a source (i.e. part of proceeds of disposition and thus biz income OR income from generic source)? NO. Additional interest not actually ‘interest’; more like punishment. Fact that TP had enforceable right to money and actively solicited it not determinative. Payment didn’t flow from performance or breach of market transaction; source was legislation; no bargain, no agreement, no quid pro quo; not earned.
Schwartz: Partner in law firm offered job by client. Signed employment agreement and gave notice to firm. Client backed out of agreement. Schwartz sued for breach and parties settled out of court for $400K. $400K income from source (employment income, retiring allowance, generic source)? NO. Not employment income b/c employment never started; he didn’t render services. Not retiring allowance b/c such an allowance compensates for past services and there were none. Not income from generic source b/c it is type of income contemplated by retiring allowance but doesn’t fit w/in words of section. Specific trumps general.
Shaw and Wilder: see above
An income tax shall be paid, as required by this Act, on the taxable income for each taxation year of every person resident in Canada at any time in the year.
Where a person is not taxable under sub (1) for a taxation year
was employed in Canada,
carried on a business in Canada, or
disposed of a taxable Cdn property
at any time in the year or a previous year, an income tax shall be paid, as required by this Act, on the person’s taxable income earned in Canada.
Cdn residents subject to tax on their worldwide income. Non residents only subject to tax on income from Canadian sources.
When is a “person resident in Canada”?
case law residents (Thomson, Schujahn, Lee, Min Shan Shih, Griffiths)
If not case law resident may be deemed residents (s. 250) [only applies where person is not resident in Canada under case law principles]
*Note that case law rules allow for part-year residence. Deeming rules deem person to be resident (and therefore taxed) for the entire year.
Person shall be deemed to have been resident in Canada throughout a taxation year if the person
(a) sojourned in Canada in the year for a period of, or periods the total of which is, 183 days or more…
Residence is Q of fact and residence has no special or technical meaning
Burden of proof is on TP to prove that he is not resident (Thomson)
Must be resident somewhere for tax purposes (Thomson). If TP leaves Cda but hasn’t established significant enough ties with another juris to be taxed there, he is unlikely to have broken tax ties w/ Cda [Thomson, IT-Bulletin]
Can have more than one residence for tax purposes [Thomson]
TP is resident in Cda if Cda is the place where he, in the settled routine of his life, regularly, normally or customarily lives. Pattern of behaviour, routine is important. [Thomson] [most significant factor]
Physical presence in Cda need not be continuous (3-4 months each year is sufficient when it is part of a regular annual routine, i.e. doing it for one or two years might not be enough) [Thomson]
Significant residential ties include (a) individual’s dwelling place, home ownership; (b) family ties (spouse and dependents in particular) (Thomson). Family ties not determinative [Schujahn, Shih, Griffiths]. Ownership of house not determinative [Schujahn]
Secondary residential ties include
Personal property in Canada
Social ties with Canada (e.g. membership in church)
Economic ties with Cda (ownership of property – Thomson; bank accounts)
Landed immigrant status or work permits in Cda
Hospitalization or medical insurance coverage from Cda
Seasonal dwelling place or leased dwelling place in Cda
Memberships in Canadian unions or professional organizations (Lee)
Intention to reside in a particular place don’t play direct role in determining residence. Intention may, however, play role in determining why certain factors which would otherwise weigh heavily in favour of residence (e.g. family ties) do not make person resident (Schujahn, Lee, Shih). Intention in sending family to Cda or leaving them there relevant (Schujahn, Shih)
Where TP has resided in Cda for lengthy period of time, clear and “virtually irreversible” measures are required to terminate this residency (Thomson). [SH: much easier to avoid becoming resident than to cease being resident – see Shih]
TP lived in NB for 15 years.
1922: Left NB and announced he was going to become resident of Bermuda. Got Bermudian passport, bought house in Bermuda, and signed affidavit saying that it was his intention to reside there.
1922-32: spent most of his time in the US but didn’t pay tax there.
1932: Wife said wanted to go back to Cda. They bought summer house in NB and spent four months per year there. During rest of year – golfed in US.
1940: declared himself US resident for tax purposes and started to pay US taxes.
Held: resident of Cda during 1940 taxation year (see reasons above)
TP was US citizen sent to Cda by his employer
In August 1957, his employer sent him back to the US. His wife and child remained in Cda until March 1958
TP argued that he ceased being resident in August 1957, and that wife and child only stayed in Cda b/c it was easier to sell an occupied house
Issue: Resident in Canada until March 1958
Held: No – ceased being resident in Aug. 1957
The only reason wife and child stayed was to facilitate sale of house. Absent that fact, he would have been considered a dual resident for tax purposes.
Why didn’t sojourning rule apply here? B/c only applies to period of time in which person is not otherwise resident of Cda. TP here was case law resident until Aug. 1957, after which time the sojourning rule might have applied (likely didn’t in this case b/c min of 183 days not met).
Note that if SJ rule had applied, he would have been required to pay taxes for entire year; case law resident can be part-year resident and pay taxes for part of year only.
Lee was English subject/resident employed outside of Canada
Entered Cda as a visitor, met a woman, married her, and guaranteed mortgage on her house
Never became a permanent resident but visited wife in Cda whenever wasn’t working
Held: Resident in Canada from day he married
Family tie significant enough to make him resident for tax purposes
Taiwanese citizen and resident sent wife and kids to Regina for four years so that kids could attend school
He remained in Taiwan for 300 days of the year, kept a home there, and worked there. He occasionally visited his family in Canada.
Held: not resident in Cda
fact that kids attended school in Cda not enough to make their father resident in Cda for tax purposes
Significant that had very strong ties to Taiwan [Allard: if had roving business or no strong ties to any particular country, might have been resident in Cda on basis that strongest ties were to Cda and he had to have residence somewhere]
POINT: Significance of family ties to Canada depends on intention in sending family to Canada or leaving family in Canada
TP had been resident in Canada for most of his life
He retired, separated from his wife and moved to the British Virgin Islands to live on a yacht
His wife remained in Cda and owned a home in Cda. He spent a few days every year in her home, and retained professional contacts in Canada
Held: not resident in Cda for tax purposes
Doesn’t matter that he was separated and not legally divorced – couple had amicably split and reached an understanding that they were not going to live together
Fact that he spent a few days every year in her house wasn’t enough to make him resident
R & L Distributors
Two R&L Distributors shareholders lived in Detroit and traveled to Windsor to work at the co.
SHs argued that they were Cdn residents for tax purposes under the ‘sojourning rule’ in 250(1)(a) [b/c would result in huge tax break for co.]
Held: not resident in Cda
Sojourning rule is only relevant when one is not otherwise a resident of Cda
Dictionary def’n of “sojourn” – temporary residence, remain and reside for a time. Suggests that some residential type factors must be present (e.g. home, social or family ties).
POINT: sojourning rule only applies when one is not otherwise a resident of Cda. Sojourning requires some residential type factors (i.e. social or family ties). Casual residence in Cda (e.g. to work) not sufficient.
Shpak originally lived in BC, and decided to move to the US. Sold home and moved to US, but continued to work in Cda
Held: case law resident
Social and family ties to Cda were significant enough to make TP resident of Cda
Strange result b/c case law rules should require more than sojourning rules do. Same facts as R&L, yet TP here resident per case law rules, and TP in R&L not resident, even under sojourning rules
Big difference – social and family ties
Also, result might change after lived in US for 10 years
**Easier to not become a resident than to lose residence
Courts have relied on this provision to expand the concept of residence such that, even if TP was not physically present in Cda in a given year, could still be resident if there was presence in prior or subsequent years
Effectively broadens the period of time that a court can look at to determine residence for a given taxation year. Note that court in Thomson was quite comfortable in finding residence w/o relying on 250(3).