CTP_(08)_Chapter_06 - Chapter 6 Income From Property ©...

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Unformatted text preview: Chapter 6 Income From Property © 2008, Clarence Byrd Inc. 1 Income From Property ► The General Concept Little Or No Effort Required Some Different Rules Includes Interest, Rent, Dividends, And Royalties Does Not Include Capital Gains © 2008, Clarence Byrd Inc. 2 Interest As A Deduction ► Concepts All Deductible None Deductible Canadian Approach © 2008, Clarence Byrd Inc. 3 Interest As A Deduction ► Proposed Legislation Loans to employees and shareholders Acquisition of preferred shares Investment in business Funds borrowed for distributions © 2008, Clarence Byrd Inc. 4 What Is Interest? ► Must Accrue On A Continuous Basis ► Must Be Calculated On A Principal Sum ► Must Be Compensation For The Use Of That Principal Sum © 2008, Clarence Byrd Inc. 5 Interest As A Deduction ► Non­Deductible Amounts RRSP Loans Personal Property Loans Late Income Tax Payments © 2008, Clarence Byrd Inc. 6 Direct Or Indirect Use ► The Direct Use Must Be Considered The Queen vs. Singleton Direct Use To Invest Capital In Partnership Indirect Use to Finance Home Economic Reality Cannot Override Direct Use © 2008, Clarence Byrd Inc. 7 Exceptions To Direct Use ► Filling The Hole New Debt Replaces Other Forms Of Capital © 2008, Clarence Byrd Inc. 8 Exceptions To Direct Use ► Interest­Free Loans Loans To Subsidiaries To Produce Income Loans To Employees © 2008, Clarence Byrd Inc. 9 Linking To Current Use ► The Current Use Of The Borrowed Money Establishes Deductibility © 2008, Clarence Byrd Inc. 10 Disappearing Source Rules ► An investment financed with debt is sold for proceeds that are less than the debt ► Insufficient proceeds to pay off all of debt ► ITA 20.1 deems the remaining debt to be producing income and interest is therefore deductible © 2008, Clarence Byrd Inc. 11 Investments In Common Shares ► Dividend income is often less than interest on borrowings ► IT­533 – CRA will consider most interest on share borrowings to be deductible © 2008, Clarence Byrd Inc. 12 Discount and Premium on Debt ► Economics Discount is an addition to interest cost (pay back more than what you received) Premium is a reduction in interest cost (pay back less than what you received) © 2008, Clarence Byrd Inc. 13 Discount – Issuer ► Deductible interest based on coupon (stated) rate ► Excess of amounts paid to retire bonds over proceeds received from sale is a fully deductible Business Loss at maturity, if: Bonds Issued For Not Less Than 97% Of Maturity Value Effective Yield Not More Than 4/3 Of Stated Rate © 2008, Clarence Byrd Inc. 14 Premium ­ Issuer ► Other taxpayers Premium is a non­taxable receipt ► Deliberate creation of a premium Interest paid will be reduced to a “reasonable” amount over the life of the debt ► Money lenders Premium taken into income immediately © 2008, Clarence Byrd Inc. 15 Interest As An Inclusion ► Corporations ITA 12(3) Requires Full Accrual Generally The Same As GAAP © 2008, Clarence Byrd Inc. 16 Interest As An Inclusion ► Individuals ITA 12(1)(c) Allows Use Of Cash Basis, Receivable Basis, Or Full Accrual ► Accrual Rules ­ ITA 12(4) Interest must be accrued on each anniversary date of debt © 2008, Clarence Byrd Inc. 17 Discount And Premium Example: Bonds with a maturity value of $1,000,000 are issued at a price of $980,000. Interest at 10 percent of maturity value is paid annually and bonds mature in 20 years. Interest Expense BondsPayable ­ Discount Cash $101,000 Cash Bond Investment Revenue $100,000 1,000 $ 1,000 100,000 $101,000 Tax Expense And Revenue © 2008, Clarence Byrd Inc. 18 At Maturity Investor: The extra $20,000 received is a capital gain (taxable amount equals $10,000). Issuer: The extra $20,000 paid is a deduction. ITA 20(1)(f) ­ Fully deductible if: ­ Issue price not less than 97% of face value, and ­ Effective yield does not exceed 4/3 of stated yield. Otherwise: An allowable capital loss (1/2 deductible) © 2008, Clarence Byrd Inc. 19 Prescribed Debt Obligations ► ITR 7000(1)(a) ­ Zero Coupon Bonds ► Use Effective Rate ► ITR 7000(1)(b) ­ Stripped Bonds ► Use Effective Rate ► ITR 7000(1)(c) ­ Rate Increases Over Time ► Use Effective Rate Based On Maximum ► ITR 7000(1)(d) ­ Contingent Rate ► Maximum Payable For The Year © 2008, Clarence Byrd Inc. 20 Example Example: Purchase debt obligation for $1,000. At maturity after five years it pays $1,762 (effective yield = 12 Percent). Year 1: [(12%)($1,000)] = $120 Year 2: [(12%)($1,120)] = $134 Year 3: [(12%)($1,254)] = $150 Year 4: [(12%)($1,404)] = $169 Year 5: [(12%)($1,573)] = $189 + $1,573 = $1,762 © 2008, Clarence Byrd Inc. 21 Indexed Debt Obligations ► Interest And Principal Determined By Changes In The Purchasing Power Of Money ► Indexed Amount Must Be Included In Income Even If Not Received By The Investor © 2008, Clarence Byrd Inc. 22 Accrued Interest ► On October 1, 2008 buy $100,000 bond with interest payable at 10 percent on December 31, 2008. Price = $107,500 $7,500 will be included in the income of the transferor $7,500 can be deducted by the transferee ­ ITA 20(14) © 2008, Clarence Byrd Inc. 23 Accrual Rules Example ► Example: Five year, $100,000 bond is issued on January 1, 2005. Pays annual interest of 10 percent only at maturity. No cash flow until maturity Would have to record interest on each January 1, regardless of when bond purchased. © 2008, Clarence Byrd Inc. 24 Payments Based On Production Or Use ► Rents ► Royalties Can Be Earned Income For RRSP Purposes Only If Writer, Composer, Inventor, Etc. © 2008, Clarence Byrd Inc. 25 Rental Income ► General Rules Rents Included On An Accrual Basis Deductions ►Interest ►Property Taxes ►Maintenance ►Management Fees ►CCA (Restricted) © 2008, Clarence Byrd Inc. 26 Rental Income Example An individual acquires a rental property at a cost of $120,000 (ignore land cost). It is rented for $1,200 per month and has a $90,000, 9 percent mortgage. Condo fees are $150 per month and property taxes are $3,000 per year. Rents Taxes ($3,000) Interest ( 8,100) Condo Fees ( 1,800) Net Before CCA CCA [(4%)($120,000)(1/2)] Net Rental Income © 2008, Clarence Byrd Inc. $14,400 ( 12,900) $ 1,500 ( 2,400) Nil 27 Special Rules ► Separate Class For Each Rental Property With A Cost Greater Than $50,000 ► CCA Cannot Be Used To Increase Or Create A Rental Loss © 2008, Clarence Byrd Inc. 28 Cash Dividends ­ Integration I get the same after tax amount by either route!!! Corporation © 2008, Clarence Byrd Inc. 29 Gross Up Tax Credit Procedures Non-Eligible Dividends Corporation Earnings $100,000 Taxes At 20 Percent ( 20,000) Available For Dividends $ 80,000 Dividends Paid $ 80,000 Gross Up (25%) 20,000 Taxable Dividends $100,000 Tax At 45 Percent (29% + 16%) $ 45,000 Dividend Tax Credit (2/3 + 1/3) ( 20,000) Total Taxes Payable $ 25,000 Cash Retained ($80,000 - $25,000) $ 55,000 Direct Receipt ($100,000)(1 - .45) $ 55,000 © 2008, Clarence Byrd Inc. 30 Eligible Dividends Defined ► Amounts paid to Canadian residents by: Public corporations resident in Canada that are subject to general rates CCPCs out of active business income taxed at general rates CCPCs out of eligible dividends received © 2008, Clarence Byrd Inc. 31 Gross Up And Tax Credit Procedures Eligible Dividends Corporation Earnings $100,000 Taxes At 31.035 Percent ( 31,035) Available For Dividends $ 68,965 Dividends Paid $ 68,965 Gross Up (45%) 31,035 Taxable Dividends $100,000 Tax At 45 Percent (29% + 16%) $ 45,000 Dividend Tax Credit (11/18 + 7/18) ( 31,035) Total Taxes Payable $13,965 Cash Retained ($68,965 - $13,965) $55,000 Direct Receipt ($100,000)(1 - .45) $55,000 © 2008, Clarence Byrd Inc. 32 Investment Returns ► For individual in maximum bracket the tax rate would be: Interest = 43.0% Capital Gains = 21.5% Non­eligible dividends = 28.8% Eligible dividends = 23.6% © 2008, Clarence Byrd Inc. 33 Income Trusts ► How do they work? (current rules) Distribute 100% of free cash flows No tax at trust level Distributions retain character and include amounts that are a return of capital © 2008, Clarence Byrd Inc. 34 Income Trusts ► Change in 2011 There will be tax on distributions Distributions will be eligible dividends with gross up and credit Not a big deal for most resident individuals © 2008, Clarence Byrd Inc. 35 Income Trusts ► Adjusted Cost Base Starts with cost Amounts reinvested are added Return of capital is deducted © 2008, Clarence Byrd Inc. 36 Mutual Fund Dividends ► Mutual fund distributions retain character Capital gains Interest Dividends – eligible and non­eligible © 2008, Clarence Byrd Inc. 37 Mutual Fund Dividends ► Mutual Funds Distribute Earnings Subject to tax Even if reinvested Reinvestment amount added to ACB © 2008, Clarence Byrd Inc. 38 Stock Dividends ► Treated exactly like cash dividends for tax purposes ► Treatment discourages use by public companies ► Amount of dividend added to adjusted cost base of shares © 2008, Clarence Byrd Inc. 39 Capital Dividends ► Paid from non­taxable portion of capital gains. Received Tax Free Does Not Reduce ACB ► Will be covered in Chapter 13 © 2008, Clarence Byrd Inc. 40 Foreign Source Income ► Non­Business Income Include 100 percent in net income Will receive a credit against tax payable for amounts withheld Credit maximum is 15 percent Excess a deduction No carry over © 2008, Clarence Byrd Inc. 41 Foreign Source Income ► Business Income Include 100 Percent In Net Income Will Receive Credit Against Canadian Tax Payable For Foreign Taxes Withheld (No Limit) Carry Over Of Unused Amounts (Back 3, Forward 7) © 2008, Clarence Byrd Inc. 42 Foreign Source Income (Example) ► Earn $1,000, receive $850 ► $1,000 in income ► Taxes @ 40% equal $400 ► Credit of $150 leaves $250 ► Total $150 + $250 = $400 (same as if received in Canada) © 2008, Clarence Byrd Inc. 43 © 2008, Clarence Byrd Inc. 44 ...
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