Tips

Auto Limits

Each year in December, the Department of finance announces changes to the allowable deductions for the purchase, lease, finance costs, and car allowances for the business use of vehicles as well as to the taxable benefits for the personal use company vehicles. As the changes are effective for 2003, owner/managers should be aware of the impact of these new rates for the 2003 tax year.

Most cars and vans that seat more than three but less than ten people are considered passenger vehicles. Deductible expenses include license and registration fees, payments for fuel, insurance, interest for financing, leasing costs, capital cost allowance (CCA), maintenance and repairs. If you use your car for both business and personal use, the expenses are prorated according to your use of the vehicle for business purposes. There are further restrictions on the deductions for capital cost allowance, interest and leases for passenger vehicles owned by a company or used for business purposes.

The ceiling on the capital cost of passenger vehicles for capital cost allowance (CCA) purposes will remain at $30,000 (plus applicable federal and provincial sales taxes) for purchases after 2002. The ceiling restricts the cost of a vehicle on which CCA may be claimed for business purposes.

The limit on deductible leasing costs will remain at $800 per month (plus applicable federal and provincial sales taxes) for leases entered into after 2002. This limit, which ensures that the level of deductions for leased and purchased vehicles is consistent, is one of two restrictions on the deduction of automobile lease payments. A separate restriction prorates deductible lease costs where the value of the vehicle exceeds the capital cost ceiling.

The limit on the deduction of tax-exempt allowances paid by employers to employees will increase to 42 cents per kilometer for the first 5,000 kilometer driven and 36 cents for each additional kilometer. For the Yukon Territory, Northwest Territories and Nunavut, the tax-exempt allowance will rise to 46 cents for the first 5,000 kilometer driven and 40 cents for each additional kilometer. The allowance amounts reflect the key cost components of owning and operating an automobile, such as depreciation, financing, maintenance and fuel costs.

The maximum allowable interest deduction for amounts borrowed to purchase an automobile will remain at $300 per month for loans related to vehicle acquired after 2002. This limit reflects the reasonable cost of financing a vehicle for business purposes.

The general prescribed rate used to determine the taxable benefit relating to the personal portion of automobile operating expenses paid by employers will increase to 17 cents from 16 cents per kilometer. For taxpayers employed principally in selling or leasing automobiles, the prescribed rte will be increased to 14 cents from 13 cents per kilometer. The amount of the benefit reflects the cost of operating an automobile. The additional benefit of having an employer-provided vehicle available for personal use (i.e. the automobile standby charge) is calculated separately and is also included in the employee's income.

The Government reviews these rates and limits annually and announces any planned changes prior to the end of the calendar year. This practice ensures that businesses know the new rates before the beginning of the year in which they apply.

Documentation Required for Tax Preparation

1. Copy of last year's assessment notice.

2. All information T slips

3. Other income for which no T slip has been received.

• Self-employed income
• Rental income
• Alimony received
• Pension income

4. Other expenses:

• Employment expenses (provide T2200)
• Carrying charges
• Moving expenses
• Alimony paid
• Vehicle expenses (provide vehicle log)

5. Details of:

• Any capital dispositions
• Any RRSP Home Buyers Plan withdrawals and repayments
• Any foreign investments in excess of $100,000
• Any income or distribution from foreign trusts
• Any loans to foreign trusts
• Any lump-sum payments received

6. Receipts for:

• RRSP Contributions
• Professional dues
• Charitable donations
• Medical Expenses
• If dependent at university - copy of T2202A completed on back and signed by student
• Tuition fees
• Interest paid on student loans
• Political contributions
• Childcare expenses

7. Statement of installment balance at the end of the year

8. Canada Customs and Revenue Agency mailing labels

Personal Tax Changes

There are no changes to personal income tax rates. Full indexation of personal tax credits and brackets based on inflation will continue. The 2003 top marginal tax rate in Quebec remains at 48.22% (24.11% for capital gains and 32.82% for dividends). The 2003 Ontario top marginal rate remains at 46.41% (23.21% for capital gains and 31.33% for dividends).

The annual RRSP contribution limit will be increased to $14,500 for 2003, $15,500 for 2004, $16,500 for 2005 and $18,000 for 2006. The RRSP limit will be indexed starting in 2007.

The money purchase RPP limit will be increased to $15,500 for 2003, $16,500 for 2004 and $18,000 for 2005. Corresponding increases will be made to the maximum pension limit of $1,722 per year of service for defined benefit RPPs, thus raising the limit to $1,833 for 2004 and $2,000 for 2005. The RPP limits will be indexed starting in 2006.

A shareholder or employee who is provided with an automobile will now be able to reduce the standby charge where the automobile is used primarily (more than 50%) for business purposes and the personal kilometers driven do not exceed 20,000 km in the year. Previously, the reduction was available only if business use was 90% or more and if personal kilometers did not exceed 12,000 km.

An individual is currently allowed to defer the taxation of capital gains realized on the sale of shares or certain eligible small business corporations when a substitute investment is made. This deferral was available for investments and reinvestments of no more than $2 million. The $2 million limits are eliminated. As well, the time limit to reinvest is extended to 120 days after the end of the year in which the original disposition occurs.

Medical expenses eligible for the medical expense tax credit will now include voice recognition software and certain expenses incurred by those with speech or hearing impairments or celiac disease.

The Canada Child Tax Benefit will increase per child by $150 in July 2003 and by $185 in July 2005 and 2006. With annual indexation, the maximum benefit for the first child will reach $2,632 in July 2003 and $3,243 in July 2007. The income threshold at which the National Child Benefits is reduced will be adjusted to remain at its July 2003 level for the first child.

A new Child Disability Benefit of $1,600 is introduced as a supplement to the Child Tax Benefit for a child eligible for the disability tax credit. The new disability benefit will begin to decrease at an income level of $33,487 and will be eliminated at $46,602 for a family with one disabled child. The new disability benefit will be effective as of July 2003 and become payable in March 2004.

Corporate Tax Changes

The small business deduction currently applies to the first $200,000 of active business income of a Canadian-controlled private corporation ("CCPC"). The amount of income eligible for the deduction will be increased to $225,000, $250,000, $275,000 and $300,000 for the 2003, 2004, 2005, and 2006 calendar years respectively. These amounts will be prorated for taxation years that straddle December 31.

As a consequence of the increase in the small business deduction limit the taxable income threshold at which CCPCs may earn investment tax credits at the enhanced 35% rate will now be phased out where taxable income in the previous year is between $300,000 and $500,000. The phase-out based upon taxable capital levels will hot change.

The federal capital tax (large corporations tax) will be eliminated over a five-year period starting January 1, 2004. In addition, as of January 1, 2004, the threshold for application of the tax will be increase from $10 million to $50,000 million of capital.

The film or video production services refundable tax credit will increase form 11% to 16% of qualified Canadian labour expenditures incurred by eligible corporations.

The definition of a tax shelter has been broadened. It will now include arrangements whereby property is acquired with the intention of being donated as a gift or where a gift is made using limited recourse debt. This will increase the compliance requirements of such arrangements and may lead to a limitation on their tax benefits.

A series of changes will be gradually implemented with the goal of harmonizing the administrative provisions of all of the various federal tax laws. These changes will affect the accounting, interest and penalty provisions of the federal income tax, GST and customs legislation as well as the non-GST provisions of the Excise Tax Act. The first series of changes proposed will affect only income tax legislation and the non-GST provisions of the Excise Tax Act.

As a result of recent court cases, legislative amendments to the interest deductibility rules are being considered. Legislative amendments facilitating cross-border share-for-share exchanges are also being contemplated.

New Canada Customs and Revenue Agency ("CCRA") Policy on Gifts and Awards to Employees

Recently, the CCRA announced a broadening of its policy on tax-free gifts and awards that can be given to employees. The changes below apply retroactively to January 1, 2001:

• Employers can now provide two non-cash gifts per year to each employee for special occasions such as Christmas, Hanukkah, birthdays and marriages provided that the total cost of the two gifts including taxes is not in excess of $500. If the cots of the gifts exceed $500, all gifts to the employee are taxable. Gift certificates for these purposes are not considered to be "non-cash".

• Similar to the change in rules with respect to gifts, the CCRA announced that employees can receive up to two non-cash awards during the year without tax implications provided the total cost of the awards do not exceed $500. To meet these rules, awards should not be given as disguise salary payments and should be in recognition of achievements such as years of service, meeting or exceeding safety standards or reaching similar milestones. If the cost of the awards including taxes exceeds $500, the entire amount will be taxable to the employee.

The new rules regarding gifts and awards each apply on their own such that an employee can receive up to two non-cash gifts and two non-cash awards in one year without tax implications, provided that each does not exceed its respective $500 cost limitation. In both cases, the cost of the gifts and awards would be deductible to the employer.

Shareholder Loans

Under the shareholder loan provisions of the Income Tax Act, a shareholder of a corporation who become indebted to the corporation or to any related corporation is required to include the amount of the debt in income, unless the debt falls within one of the exceptions discussed below.

The provisions can also apply to a person who does not deal at arm's length with the shareholder, if such person becomes indebted to the corporation. Thus, for example, if the shareholder's spouse receives a loan from the corporation, the amount of the loan will be included in the spouse's income, unless on of the exceptions applies.

The amount include din the shareholder's income (or the non-arm's length person's income) is treated as ordinary income and not as dividend. Accordingly, the amount is not eligible for the dividend tax credit. Furthermore, the corporation will not be allowed a corresponding deduction, so that there will normally be double taxation.

Fortunately, there are some exception to the shareholder loan provisions. Where an exception applies, the loan or debt is not include din the shareholder's income. The major exceptions are described below.

Exceptions where shareholder loan rules not applicable

Loans made for specified purposes

A loan from a corporation is not included in an individual's income if:

1. the individual is an employee of the lender corporation but not a specified employee. In general terms, a specified employee is an employee who owns 10% or more of the shares of any class in the lender corporation or in a related corporation;

2. the individual is an employee of the lender corporation or is the spouse or common-law partner of the employee, and the loan is used to acquire a home;

3. the individual is an employee and the loan is used to purchase newly issued shares of the employer corporation or of a related corporation; or

4. the individual is an employee and the loan is used to acquire a motor vehicle to be used in the performance of the employee's duties of office or employment.

In order for any of these exceptions to apply there are two additional requirements.

First, it must be reasonable to conclude that the employee (or the employee's spouse or common-law partner, as the case may be) received the loan because of the employee's employment and not because of any person's shareholdings.

Second, at the time the loan was made, bona fide arrangements must have been made for repayment of the loan within a reasonable time.

Loans made in ordinary course of corporation's business

The shareholder loan provisions do not apply if the loan or debt arises in the ordinary course of the corporation's business and bona fide arrangements are made, at the time the loan or debt arises, for repayment within a reasonable time.

The ACCRA take the view that trade debts that arise in the ordinary course of a business from the sale of goods by the corporation to the shareholder, on the same terms for payment as sales to other customers of the corporation, will fall within this exception.

If the corporation is in the business of lending money, the CCRA takes the view that a shareholder who receives a loan from the corporation will fall within this exception if the terms and conditions attached to the loan are the same as for another person who does not own, or is not related to someone who owns, shares in the corporation.

Repayment of loan by the end of the corporation's next taxation year

A shareholder loan is not included in income if it is repaid within one year after the end of the corporation's taxation year in which the loan was made. Accordingly, in some circumstance, the loan will not have to be repaid for almost two years under this exception. For example, if a corporation's taxation year-end is December 31 and a shareholder loan was mad on January 1, 2003, the shareholder will have until December 31, 2004 to repay the loan under this exception.

This exception does not apply if it is reasonable to conclude that the the repayment of the loan was part of a series of loans and repayments. For example, you likely will not be successful if you try to use this exception two or three times in a row, by borrowing an amount, repaying the amount in the next year, re-borrowing the same amount, and so on.

However, repayments of shareholder loans that result form the payment or crediting of dividends, salaries, or bonuses from the corporation to the shareholder are not normally considered to be part of a series of loans or other transactions and repayments.

Deduction when loan repaid

If the shareholder repays part or all or a loan that was previously included in income under the shareholder loan provisions, the amount of the repayment is deductible. However, the deduction is allowed only if it is clear that the repayment of the loan was not part of a series of loans and repayments.

Deemed interest benefits for low-interest loans

If a shareholder loan is not include din the shareholder's income because of one of the exceptions, the shareholder may nonetheless be taxed on a deemed interest benefit if the loan bears a less than adequate rate of interest.

This "deemed interest benefit" rule provides that the shareholder/debtor must include in income the amount, if any, by which 1) the interest computed on the loan using the prescribed rate of interest in effect during the year, exceeds 2) the total interest paid on the loan during the year or within 30 days after the end of the year.

For the first two quarters of this year up to June 30, 2003, the prescribed rate of interest for these purposes was 3%. However, it has increased to 4% for the quarter starting on July 1, 2003 and ending on September 30, 2003.

Note that the shareholder loan provisions and the deemed interest benefit provisions cannot apply at the same time. In other words, you can be taxed under one of the provisions but not both.

Gifts and Awards

Gifts and awards given by employers to their employers to their employees

The CCRA is reminding employers about how gifts and awards given to employees are taxed. A policy change that came into effect in 2001 makes it easier for employers to administer their gifts and awards programs because it removes the burden of determining the fair market value or small gifts and awards.

• Employers are reminded that the policy does not apply to cash or near-cash gifts and awards. Near-cash is any item that can be readily converted to cash or that is equivalent to cash.

• Employers are encouraged to contact the CCRA's Business Inquiries line at 1-800-959-5525 to make sure that any gifts or awards they plan to give their employees fall within the specific guidelines.

The mark special occasions such as Christmas, Hanukkah, birthday, or a marriage, employers can give their employees two non-cash gifts per year on a tax-free basis. In addition, to honor achievements such as years of service or meeting safety standards, employers can give their employees two non-cash awards per year on a tax-free basis.

The two gifts or the two awards total cost to the employer, including taxes, cannot be over $500 per year.

Employers can deduct the total cost of the gifts or awards from their income.

Employees do not have to declare the cost of the gifts or awards as part of their taxable income.

If the cost of each gift or award is over the $500 limit, the employer must include the full fair-market value of the gift(s) or award(s) in the employee's income.

If an employer give two or more gifts -- or two or more awards -- in a single year and their total costs is over the $500 limit, the employer may have to include the fair-market value of one or more of the gifts or awards in the employee's income.

This is determined by the cost of each gift or award, and also by the number of gifts or awards given in a single year.

The new policy does not apply to cash or near-cash gifts and awards such as gift certificates, gold nuggets, or other items that can easily be converted into cash. The value of this type of gift or award is considered a taxable employment benefit.

Arthur B. Rubin Professional Corporation periodically provides public information as a service to clients, staff and other interested parties. Its objective is to inform the reader about current developments in the field of taxation. The topics included are of a general nature and are not intended to provide a complete analysis of any subject. Although every effort has been made to ensure the accuracy of the information included as of the date on which it was issued, consideration must be given to the particular facts in each circumstance as well as changing laws and policies before implementation of any concepts.