Index of Articles
Personal Assets Held in a Corporation
Start Preparing Now for New Reporting Rules
New Accounting Standards for Private Enterprises in Canada Finalized
Tax Free Savings Accounts
Personal Assets Held in a Corporation
One of the most common errors that we identify is the belief that private corporations can hold personal use assets. The shareholders of the corporation will often believe that it is tax efficient to purchase assets inside the corporation that would otherwise involve the withdrawal of funds from the corporation to purchase such assets (which would be a taxable withdrawal). Unfortunately, the tax consequence of the acquisition of personal use property by a corporation is not pretty. We often see vacation homes, automobiles, boats, art collections, etc. owned by the corporation. Certainly the most common examples we are questioned on is vacation property and in some unusual cases the primary residence of the shareholder(s).
There has been no shortage of tax jurisprudence involving this type of issue. The biggest tax consequence is that the shareholder(s) will usually have been considered to have received a taxable benefit from the corporation. In other words, the corporation conferred a benefit on the shareholders. This benefit is then added back to the personal income of the shareholders.
When dealing with personal use real estate property, additional tax consequences can result given that the fact that the principal residence exemption will not be available upon an ultimate disposition of the property by the corporation. Accordingly, personal use property owned by a corporation can be a tremendous headache with very little planning available to offset the negative consequences. Our usual recommendation is to always remove personal use property from a corporation so as to relieve oneself from the significant taxable benefits and headaches that surround this matter.
Start Preparing Now for New Reporting Rules
Jim Middlemiss, Financial Post
As of Jan. 1, 2011, small and medium Canadian companies will have to decide what standard to use in reporting their financial statements.
They must choose whether to stick with Canadian Generally Accepted Accounting Principles (GAAP) or adopt a global initiative known as the International Financial Reporting Standard (IFRS).
Publicly-traded companies don't have an option: They will be required to use IFRS.
While 2011 might sound far away, it's not. The real legwork for those who want to -- or must -- adopt IFRS will take place in 2010, say lawyers and accountants. That's when companies must start tinkering with their accounting systems and preparing to produce statements that meet the seal of approval created by the International Accounting Standards Committee and adopted by the International Accounting Standards Board in a bid to bring harmony to the world in financial reporting.
"The next six months is pretty crucial for a lot of private companies," said Tahir Ayub, leader of the Alberta private company services practice at Pricewaterhouse-Coopers.
"A lot of private companies who haven't really thought about this should be talking to service providers to discuss which option best fits their circumstance."
Robert Young, a partner in KPMG's national assurance and professional practice, said the changes will be noticeable. "IFRS is going to be a more expansive accounting framework to maintain. There are more fair value measurements. It's more complex and expensive to generate financial statements under IFRS. They are much more detailed than they are under private Canadian GAAP."
Whether or not a company should convert depends on who it does business with and who uses its financial statements, experts say.
"If you are doing business domestically only at this point in time, I don't see any economic or business factors that would drive you to adopt IFRS," Mr. Young said.
If you have operations across the globe or are doing business offshore, the standard provides "a common accounting language that is streamlined and makes it easier to assist you," said Sal Bianco, a partner at PwC in Toronto.
"If you expect to be accessing capital from lenders other than in North America, there is a much stronger probability that the only accounting framework they will find suitable is IFRS," Mr. Young said.
Adopting the standard may also be beneficial to firms that benchmark themselves against public companies or European or Asian companies, he added.
Simon Romano a lawyer at Stikeman Elliott in Toronto, said a company's holdings should also be a consideration. Adopting IFRS now "may assist with the future sale of a business by a buyer who uses IFRS," he said. It may also help if "you later go public."
Mr. Romano also noted that companies may be required to adopt IFRS if they want to continue doing business with lenders, customers, suppliers or credit parties that are adopting it.
But he warned that adopting IFRS is complex and companies will incur transitional costs.
Mr. Young agreed, adding that companies might need to renegotiate some contracts or bank covenants. For example, a company bonus plan for employees could be affected.
"Net income will probably be more volatile than under historic Canadian GAAP," he said. "I would only go there if I perceive a business benefit of doing it."
In the end, the switch might be inevitable even for small businesses, Mr. Young said.
"In 10 years, I would expect that Canadian private companies will be using an accounting framework that is going to be a lot closer to IFRS than it is today. How close, time will only tell.
New Accounting Standards for Private Enterprises in Canada Finalized
TORONTO, September 30, 2009
The Accounting Standards Board (AcSB) approved the final accounting standards for private enterprises in Canada. The new standards will be issued by the end of the year and will be available for 2009 reporting for entities that choose to adopt them early.
The private enterprise standards give Canadian businesses the ability to choose to adopt new “made in Canada” standards or International Financial Reporting Standards (IFRSs). Private enterprises must decide which of the sets of standards to adopt for years beginning on or after January 1, 2011.
Private enterprise standards were developed from a lengthy consultation process that ensured that private enterprises of all sizes across Canada were able to provide input into the standard-setting process. Consultation was the key to producing new financial reporting standards that respond to the needs of both private enterprises and the users of their financial statements.
The new standards provide Canadian private enterprises, many of them small and medium-sized businesses, with standards that are robust, yet more straightforward to implement.
Notable changes include simplification of recognition, measurement and presentation in areas that were identified as being overly complex, particularly accounting for financial instruments. The simplified accounting requires less use of fair values. The new standards also significantly reduce the burden of disclosure requirements.
“As part of its overall strategy, the Accounting Standards Board concluded that when it comes to financial reporting standards, one-size does not fit all,” said Tricia O’Malley, Chair of the Accounting Standards Board, “We are pleased to have completed the project and given Canadian private enterprises the standards that they and their users need to function effectively and efficiently.”
“These new standards offer Canadian private enterprises and users of their financial statements genuine improvements. In analyzing the needs of private enterprises and addressing their needs and concerns, the Accounting Standards Board was careful not to make changes simply for the sake of change,” said Brian Drayton, AcSB member and Chair of the Private Enterprise Advisory Committee. “Rather, the AcSB took the opportunity to address specific areas that were brought to our attention, such as disclosures, that unnecessarily overloaded preparers without providing benefit to users. Stakeholder interest was very high and their comments and input were tremendously helpful in developing strong standards for private enterprises.”
Tax Free Savings Accounts
This article by Don Nilson, FCMA, CFP, TEP, Principal & Nilson Company/AFT Trivest ManagementTAX, appeared in CCH's Tax Topics newsletter No. 1914 dated November 2008.
Perhaps not since the hula hoop, pet rocks, and the latest Indiana Jones movie has something caused such buzz on Main Street. Everyone is talking about the new tax-free savings account ("TFSA") created in the 2008 Budget. Starting in 2009, resident individuals at least age 18 may establish one or more TFSAs through Canadian financial institutions. This new savings vehicle has attributes similar to our existing savings regime, and some nifty new features of its own. Like RESPs, but unlike RRSPs, the capital contribution does not generate a tax break, nor is the withdrawal of capital taxed. Unlike either of them — and here is the excitement — the accumulating investment income that the account earns is never taxed! Similar to RRSPs, new contribution room accumulates annually, although it is not tied to generating "earned" income. Rather, universal annual room starts at $5,000 in 2009 and is scheduled to be indexed every year in the future. You may contribute up to your accumulated room at any time in your life. Excess contributions are subject to a 1% per month penalty, as with RRSPs.
The investment rules of TFSAs generally will be the same as those that govern RRSPs, including the point that borrowing to contribute does not create deductible interest. Investment management and brokerage fees are directly deductible when incurred in a non-sheltered account, and effectively deductible when incurred in a sheltered account, but they will not be deductible for TFSA accounts.
Unlike RESPs (and special purpose education and homebuying in RRSPs), TFSA funds can be withdrawn at any time for absolutely any purpose in life. Unlike RRSPs and RESPs, you may withdraw funds from the TFSA and replace them at any time, starting in the calendar year after the year of withdrawal. In effect, then, your accumulating room, and accumulating income thereon, is a lifetime balance in the account that can ebb and flow depending upon your needs.
Existing attribution rules between spouses are irrelevant for TFSAs because they are tax-free. Thus, one spouse can fund the other's TFSA contributions. Unlike RRSPs, however, one's own TFSA contribution room must be contributed to one's own TFSA, and cannot be "spousal".
The tax treatment of TFSAs upon death will parallel RRSPs. The account can transfer directly through a "named beneficiary" election, or indirectly through the will, to a surviving spouse and retain the tax-free character. If the TFSA is inherited by someone other than a spouse, the accumulated amount at death passes tax-free to the beneficiary but the income earned in the account after death becomes taxable. In the case of capital assets (e.g., stocks), these will be marked to market upon the death, and only the gains (or losses) from this value will have a bearing for the beneficiary.
A related matter remains to be seen in the detailed legislation. In the case of the RRSP of a deceased, the executor can make a post-mortem RRSP contribution under the normal deadlines for the final tax year of the deceased. For a TFSA, will the executor be able to pay back funds borrowed at the time of death? This would be useful where there is a surviving spouse, who can then carry forward a larger TFSA account.
Like RRSPs, TFSAs can be transferred in a marital breakup.
Unlike RRSPs and RESPs, there are no age implications to TFSAs (other than attaining age 18).
Unlike RRSPs, however, the assets in a TFSA can serve as collateral against a loan.
An interesting twist is that individuals who cease Canadian residency may maintain their TFSAs and continue to earn income free of Canadian tax. No contributions may be made, however, and no annual new room will accrue. Also, any withdrawals made while non-resident may not be repaid subsequently. There likely will be tax liability, however, in the new country of residence with regards to the investment income earned in the Canadian TFSA.
Who is a good candidate to use TFSAs?
People who want a rainy day fund
Everyone can build a savings pot which earns tax-free investment income until that unexpected expenditure arises.
Low-income people
Conceptually, TFSAs were originally intended for people with low income throughout their working careers and retirement years. They would receive low marginal tax value from making RRSP savings while working. Then they would be penalized in retirement by turning that RRSP into a pension stream which might preclude them from receiving various income-tested social welfare benefits. Now, a TFSA can build up retirement savings without impairing access to these benefits.
In fact, it may be wise for low-income people to draw down their existing RRSPs before retirement to protect the entitlement to these social welfare benefits after retirement.
People who have topped up all of their RRSP contribution room
The TFSA provides another tax-incented savings vehicle when RRSP room is exhausted.
Parents who wish to help their adult children
In the past, parents might have assisted their children's house acquisition with a lump-sum gift or loan. In the future, they might accumulate their own TFSAs to save for this purpose, or perhaps fund their children's TFSA contributions towards the same purpose. Thought should be given to whether this is a gift or a loan, and the latter ought to be documented on paper in case the child's marriage should fold; otherwise, the ex in-law may walk away with half of the money.
People who wish to accumulate funds for future large expenditures, like a house, car, return to school, or family wedding
We have had a smorgasbord of savings vehicles in the past, like RHOSPs, Home Buyers' Plans, and Lifelong Learning Plans. The TFSA may be a neat and tidy one-stop shopping vehicle for these purposes in the future.
Couples with disparate incomes
Tax law thwarts various income splitting schemes between couples; however, annual TFSA contributions for a low or no-income spouse can be funded by the high income spouse, without attribution.
Parents who wish to accumulate a large education savings pool for their children
Perhaps expensive schooling is anticipated for medical or grad school or Ivy League education. RESP accumulations may not be sufficient to prepare for this. Parents could augment in their own TFSA accounts while the children are young and could contribute to their children's accounts after age 18.
People with fluctuating incomes
It is smart to use RRSP contributions as deductions when your marginal tax bracket is high — this increases the tax break associated with the contribution. One's income might fluctuate for a variety of reasons; e.g., being in and out of the workforce, having performance-based compensation (e.g., a realtor), or having large one-time income, like capital gains on real estate. In the past, one might make that RRSP contribution (with available cash) but defer the deduction claim until a better time. A problem with this is that one doesn't know when, or if, a big income year will come. But now, it may be wiser to contribute the funds to a TFSA, earn tax-free income along the way, and withdraw the funds to make an RRSP contribution when that big income year arrives. The withdrawal from the TFSA only "borrows" from your room and can be replaced another day.
An opportunity exists for the charitably minded who experience a high-income year. They might borrow from their TFSA to make a large donation to offset their high-income year. That money could be paid back to the TFSA any time in the future, or not.
Note that the relatively new, and generous, stock-gifting-in-kind tax law is irrelevant and inappropriate for any appreciated stocks in a TFSA. The capital gain in the TFSA is tax-free anyway, so this generous tax rule belongs exclusively with appreciated stocks in a Direct Trading account. On the other hand, the appreciated stock in a TFSA could be sold (tax-free) and then the cash borrowed from the TFSA could be donated.
People who anticipate large estate taxes on death
Large death taxes can arise from deemed RRIF deregistration and from deemed capital gains on stocks, real estate, and recreational properties. Traditionally, death taxes are funded either from liquidations in the estate wind-up or from some form of life insurance. TFSAs may cut into future insurance policy sales as a new, effective and cheaper means to fund these death taxes, as well as lower the death taxes themselves.
Recent retirees under age 71
To lighten the tax load in retirement transition, recent retirees might augment their lifestyle costs by drawing down their TFSAs instead of their sheltered accounts. This allows their sheltered accounts to compound through their '60s.
People who wish to fine-tune their financial management by addressing tax-smart investing strategies
This area is complex and depends upon your investment profile and marginal tax bracket. The topic is discussed below.
Prioritizing savings goals
For starters, it will be wise for anyone and everyone to use some TFSA room to finance their rainy day emergency fund and enjoy the tax-free aspect of this new account.
After building your emergency fund, determine your medium-term savings goals and prioritize them by their timelines. For instance, if house acquisition is top of the list, ensure that both of the couple have accumulated $20,000 in their RRSPs that can be withdrawn under the Home Buyers' Plan. If not, make RRSP contributions accordingly. After this, each of the couple should save through his or her TFSA room, followed by a non-sheltered account.
Education savings through RESPs needs attention next. This is particularly true if your children are older —the timeline is short to contribute, use up their lifetime room, and enjoy the significant 20% matching grant.
When your savings goals become long term, i.e., retirement, you need to determine what annual savings rate is required and affordable. Then determine if your annual savings rate is more or less than the sum of your TFSA and RRSP contribution room (we'll call this sum your "total room"). If your annual savings rate is less than your total room, save first in a sheltered account if you are not in a low tax bracket, and then in a TFSA. If you are in a low tax bracket, save in reverse order, starting with the TFSA.If your annual savings rate exceeds your total room, save first in a TFSA and in a sheltered account until you have used your total room, and then in a non-sheltered account.
If your ability to save precludes you from maximizing both of your TFSA and RRSP limits, then you must decide which of those two accounts will receive your scarce capital. The trade-offs between TFSAs and RRSPs include both tax-smart investing issues plus the tax break received from RRSP contributions (but not from TFSA contributions). Academic research has performed some number crunching on this and concluded that it may be a "wash", depending upon your income level.