1. Chapter Objectives Be able to: n Explain the nature of the different types of property income. n Differentiate between the different methods of computing interest income for individuals. n Calculate interest income to be recognized by individuals and corporations. n Calculate dividend income to be recognized by individuals and corporations. n Calculate rental income to be recognized by individuals and corporations. n Identify and explain the impact of property income taxation on investment decisions.

2. General Rules for Determining Property Income n Property income is the return on invested capital where little or no time, labour or attention has been expended by the investor in producing the return.Examples are dividends, interest, royalties and rental income. However, property income would not include the gain or loss that may result from the sale of that property. n Expenses incurred to earn property income can be deducted for tax purposes provided that they are: incurred for the purpose of earning taxable income, not an expenditure of a capital nature, not a reserve, not a personal or living expense, and reasonable in the circumstances. n Individuals can not elect a different taxation year from the calendar year, as opposed to business income where you could. n There is a general limitation on the deduction of interest. In order to deduct interest, the underlying loan must have been used to acquire property that is used to generate property income.

3. Interest Income n Corporations must recognize interest income on a daily accrual basis. n Individuals can choose between three different methods of cash, receivable and annual accrual. However, the same method must be used consistently for an investment and interest income must be recognized at least once every 12-month period from the date of the investment. Individuals can not use the daily accrual method. n Examples of related expenses are: interest on loans to acquire interest- bearing investments, investment counselling fees, loan costs (mortgage appraisal and legal), investment manager fees, safe custody costs, and accounting fees. n When interest is received from foreign sources, the interest before foreign taxes must be included in net income for tax purposes and the foreign tax withheld can be claimed as tax credit.

4. Dividend Income n Corporations: Although dividends from Canadian corporations are included in net income for tax purposes, there is an offsetting deduction in arriving at taxable income. The result is that inter- corporate dividends are not taxed. Dividends from foreign corporations are treated the same if the foreign corporation is a foreign affiliate (more than 10% owned). n Individuals: Dividends received from Canadian corporations are grossed-up 125% and included in taxable income. A dividend tax credit is granted for 13 1/3% of the taxable (grossed-up) dividend. This scheme of grossing-up the dividend and granting a tax credit is intended to eliminate the double taxation that occurs when a corporation distributes its after tax earnings to shareholders. n Dividends received from foreign sources is treated the same way as interest from foreign sources.

5. Rental Income n The determination of rental income conforms to the normal rules of profit determination including recognizing income on the accrual basis. n Examples of related expenses are: : interest on mortgages to acquire rental property, loan costs (mortgage appraisal and legal), insurance, property taxes, repairs, utilities, landscaping, and CCA on building, equipment and furniture. n There are two general limitations on CCA on rental buildings: CCA can not create or increase a net rental loss from all properties combined and rental buildings costing more that $50,000 can not be pooled with other buildings. n CCA on furniture and equipment is subject to the same net rental loss restriction but these assets can be pooled in one asset class.