tax tips

Penalties – Given the mindset of CRA and the time of year, a quick review

Failure to file an Information Return – $ 25/day, minimum $ 100 and maximum $ 2,500.  Historically, I had not seen this for late filed returns. However, I think it is becoming common practice – especially on non-resident returns even where there is no tax payable.

Income Tax Late Filing – on unpaid tax as of the due date 5% and 1% for each complete month that the return is late.   These penalties are doubled if a return was late filed in any of prior 3 years, penalties were assessed and there has been a formal demand from CRA for the filing.

Corporate Income Tax Returns filed in incorrect manner – this penalty started in 2011 and for taxation years that end after 2013 will be $ 1,000.a

Foreign Reporting  – required for:

Foreign Property – T1135 due when return due (keep in mind expanded info on 2013 form)

(NEW – no reporting on foreign stock in Cdn brokerage if T3 or T5 issued and tick the box). When you consider the penalty is 5% of the highest balance in the offshore account – with low interest rates and a flat market – that can exceed the income earned in the account!!!

Foreign Affiliate –  Form 1134A or 1134B due 15 months after year-end

Non-Resident Trusts – transfers to (T1141) or distributions/indebtedness from (T1142)

Information returns for foreign reporting are subject to the normal information return penalties ($25/day). In addition, gross negligence penalties of $ 500 times the number of months late (to maximum 24 months) can be applied where returns are not filed or are filed late.  The penalty is doubled if CRA has sent a demand to file.  These penalties are reduced by the amount of information return penalty already applied.

CRA and penalties after Second Error CRA’s much publicized position is to apply penalties on the second reporting error in a 4 year period even if first reporting error is small.  The Federal Court of Appeal has laid out the hurdle for claiming due diligence defence: “the defendant made a reasonable mistake of fact, or that the defendant took reasonable precautions to avoid the event leading to imposition of the penalty. With most penalties triggered by Tslips, it is worth keeping in mind that:

  •  CRA will almost never accept the due diligence defence – the courts might
  • Omissions in years 1 & 2 trigger penalties in year 2 – but still count if there are omissions in years 3,4 or 5 (i.e. paying the penalty does not “reset” the status)
  • Late or never received T slips sometimes are not a satisfactory due diligence defence
  • Foreign or Dividend tax credits only reduce taxes payable, not the penalty on income

Failure to Deduct at Source – the penalty is 10% of the amount that should have been deducted, double when failure was made knowingly.  Combined with deemed payment to non-residents when the amount is outstanding for 90 days or more penalties can be significant.

Threshold to assess statute barred years is lower than the threshold to assess gross negligence penalties.

Trusts

Disturbing views from CRA

Properly implemented and maintained, family trusts can be a vehicle to achieve tax savings – more now that prescribed borrowing rate is back down to 1%. However, the documentation thresholds are increasing. Recently, CRA was asked their view of the consequences of a trust distributing funds to child beneficiaries in support of an allocation of trust taxable income, followed by the children writing a cheque to the parent as a reimbursement of a portion of family expenses.  . . CRA stated “For Children can be considered as the true beneficiaries of income allocated by Trust, they must be able to dispose completely to their advantage.  Among the circumstances to be taken into account, there is:

 * How these revenues were received,

 * The control thereof,

 * Obligations and restrictions on how to dispose attached to it,

 * Its use by beneficiaries,

 * People who actually reap the benefits.  andthat the facts appear to demonstrate that the children did not have the discretion to use at their convenience all the amounts received. They acted as accommodating parties (either as agents or nominees of the father). The income should be taxed in the hands of the father. The amounts paid by the children to their father are not amounts “from or under a trust”.

Maximizing documentation of beneficiary related expenses will reduce the scope of exposure.

 

Distributions by Trust

Where property is distributed by a trust to a beneficiary in satisfaction of their capital interest in that trust, the trust is deemed to dispose of the distributed property for its cost amount and the beneficiary is generally deemed to have acquired the property at the same cost amount.   If shares are distributed, Trustees can elect on a share-by-share basis for the shares to go out at FMV.  If the beneficiary owes a debt, a portion of the distribution will be considered a sale at FMV to repay the debt.

 

Tax Planning or Tax Dreaming

Tax planning involves organizing a taxpayer’s affairs so that upon review by CRA, the filing position is maintained.  Tax Dreaming is viewing the facts through your own rose coloured glasses and hoping no one else looks.  In a recent case, taxpayers buying out a discontent daughter and her husband for $40 million preferred the latter approach.  When CRA disallowed the interest expense, the taxpayer argued

  • It was in the business of financing subsidiaries – but the financial statements showed the subsidiaries financed it
  • It was in the business of managing investments – but had no employees
  • Purchase of shares was to remove adverse impact on earnings – but was only 12.5% and no evidence on what adverse impact was from dissonance
  • Borrowing was “filling the hole” theory which is that a corporation can borrow up to retained earnings – however, the corporation was in deficit.

Planning is creating a sequence of events/transactions to optimize the outcome – NOT talking yourself into a story.

 


The remarks in this publication are general in nature.

Michael Fromstein – michael@sloangroup.ca

416-786-7644

RelatedRelated