1. Chapter 6 Income from Property 1

2. Inclusions Sec. 12 Interest income from savings, deposits, loans, bonds, and debentures; Dividends from shares; and Income based on the production or use of property. 2

3. Interest Income Reporting –Corporations, partnerships, and trusts Accrual method of accounting –Individuals Annual accrual based on the anniversary date of an investment contract Annual accrual does not apply if individual receives interest prior to anniversary date (under general rule) 3

4. Interest Income Purchasing a corporate bond at discount –Investor’s Position Is interest income equal to amount actual received or based on effective interest rate? –Issuer’s Position “Deep” discount versus “shallow” discount If a deep discount, only 50% of discount can be deducted as if it were an interest expense 4

5. Interest Income Treasury Bills –Discount included as interest income Zero-coupon bonds –Interest is paid as part of redemption proceeds at maturity –Difference between the cost of bond and the maturity value represents the present value of the accumulated interest income (compounded on annual basis for Type 1 bonds) 5

6. Interest Income Purchasing an accrued interest bond –Interest income is divided as: Transferor must include interest accrued up to the date of the transfer. Amount included in income is excluded from the proceeds of the debt obligation. Transferee must include interest from the date of the transfer. 6

7. Payments Based on Production or Use Must be included as property income Purpose of rule: To prevent taxpayers from characterizing property income as capital gains which have a lower tax rate 7

8. Dividends All dividends are income –Including dividend-in-kind –“Taxable dividends” are dividends from resident corporations –“Dividends” are dividends from non-resident corporations 8

9. Dividends from Corporations Resident in Canada (Figure 6-1) 9

10. Canadian Dividend Taxation System Issue: –Double taxation Income taxed first at the corporate level and then in the hands of shareholders as dividends. To eliminate double taxation: –Gross-up of dividend received and calculation of tax on that base, and –A dividend tax credit for income tax paid by corporation. 10

11. Canadian Dividend Taxation System Dividends from Corporations Resident in Canada Dividends from the active business income of a CCPC taxed at a low corporate rate or from investment income of a CCPC Eligible Dividends - Dividends from a public corporation or CCPC business income taxed at general tax rates Gross-up rate18%38% Dividend tax credit: Of dividends paid13%20.7% Of gross-up13/18 * 18%6/11 * 38% Of grossed up dividend11.02% * 118%15% * 138% 11

12. March 21, 2013 Proposals 12 Dividend gross-up and dividend credit be changed for dividends from: –Active business income of a CCPC that is taxed at the lower corporate tax rate –Investment income of a CCPC CurrentProposed Cash Dividend10,000 Dividend gross-up Current – 25%2,500 Proposed – 18%1,800 Grossed up dividend12,50011,800 Dividend tax credit (federal) Current – 2/3 of gross-up1,667 Proposed – 13/18 of gross-up1,300

13. Dividends Received from Non-Resident Corporations Dividends still taxable but dividend gross-up rules do not apply Entitled to foreign tax credit if income tax withheld from source 13

14. Income Attribution “Income attribution” allocates income earned on property that was transferred to a non-arm’s length individual back to original owner. Purpose: Prevent taxpayers from splitting income with family members who earn less income and pay tax at a lower rate. 14

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17. Income Attribution Avoiding Income Attributions Subsection 74.5(1) 1.FMV Transfer 2.Interest charged at prescribed rate 3.Spousal Election Subsection 74.5(3) 1.Marital Breakdown 17

18. Income Attribution Anti-avoidance rules relating to attribution –Repayment of existing indebtedness –Back-to-back loans –Loan guarantees –Artificial transactions –Compensation –Corporation 18

19. Income Attribution Does not apply to: –Second generation income from property –Loans or transfers to non-arm’s length individuals who are 18 years of age or older 19

20. Kiddie Tax Income attribution rules do not apply to income from a business transferred to a minor “Kiddie Tax” applies to dividends from a private Canadian or foreign corporation –Taxed at top marginal rate of an individual –Can only claim dividend tax credit or foreign tax credit 20

21. Kiddie Tax Income subject to Kiddie Tax: –Taxable dividends and taxable capital gains derived from private Canadian or foreign corporations and that are received directly or indirectly through a trust or partnership –Shareholder benefits included in the minor’s income under section 15 –Partnership or trust income derived from the provision of goods and services to a business that is carried on by i.A person related to the minor; ii.A corporation which has a “specified shareholder” who is related to the minor; or iii.A professional corporation which has a shareholder related to the minor. 21

22. Kiddie Tax Exceptions: –Income from a corporation or partnership paid to individuals over 18 years of age; –Taxable dividends from public corporation; –Reasonable remuneration to minors; –Capital gains on disposition of shares of private Canadian or foreign corporation; –Income from property inherited from a parent; –Minors who have no parent resident in Canada; or –Income from property inherited from someone other than a parent. 22

23. Kiddie Tax Where taxable capital gains are derived from a disposition of shares to a non-arm’s length person and if taxable dividends on such shares would have been subject to the tax on split income. An amount equal to two times these taxable capital gains will be deemed to be dividends and subject to ‘‘Kiddie Tax’’ at the top marginal rate. 23

24. Deductions Carrying Charges on Land –Limitation on deduction – Vacant land Only deductible to the extent of the net income on the land Carrying charges not deducted are added to cost base of land Applies only to property developers whose business is the sale or development of land, or to land that is held, but not used, in a business. 24

25. Deductions “Soft Costs” Relating to Construction or Buildings or Ownership of Land –Includes interest expenses, legal and accounting fees, mortgage fees, insurance, and property taxes –During construction, costs must be added to the cost or building or land –Does not include CCA, landscaping expenses, or disability-related modifications 25

26. Deductions Rental Properties –Separate classes – rental property costing over $50,000 –Losses from rental property CCA can only be deducted to the extent that it does not create or increase a net loss from all of a taxpayer’s rental properties combined. 26

27. Deductions Interest Deduction –Can deduct interest if it: is paid or payable in the year; arises from a legal obligation; is payable on borrowed money that is used for the purpose of earning income from business or property; and is reasonable in amount. 27

28. Deductions Interest deduction limitations: –Deduction of interest imposed under the Act is denied; –Deduction of interest on funds borrowed to buy vacant land is limited; –Interest that is part of “soft costs” must be capitalized; –Deduction of interest paid to certain non-residents is limited; and –Deduction of interest on funds borrowed to make a contribution to tax sheltered retirement savings fund (e.g., RRSPs) is denied. 28

29. Deductions Interest Deduction –Loss of the source of income –Election to capitalize interest 29

30. Personal Loan Planning and Interest Deductibility Strategy: –Buy personal assets with your own funds (as interest not deductible on borrowed funds used to purchase personal assets) –Use these assets as collateral to borrow to invest in assets that earn property income (since interest will be deductible) 30

31. Other Deductions Carrying charges Investment counsel fees Legal and accounting fees Foreign non-business income tax –Taxpayer allowed a tax credit up to 15% of foreign income from property –Foreign taxes paid in excess of 15% can be a deduction against property income 31

32. GST/HST and Property Income Interest and dividends exempt from GST/HST “Soft Costs” –GST/HST applies to sales and rentals of real property unless the supply is specifically exempt under Part I of Schedule V (e.g., sales of used residential housing and long-term residential rents) –Input tax credits can be claimed if property and services are purchased for use in commercial activities 32