Articles in this issue:
- Late Filed Corporation Tax Returns Can Result in Significant Financial Repercussions
- Registered Disability Saving Plan
- Transfer Pricing Studies The Cost of Non-Compliance
- Changes to the Principal Residence Exemption Reporting
Late Filed Corporation Tax Returns Can Result in Significant Financial Repercussions
Written By: John Grummett, CPA, CA
Taylor Leibow LLP Accountants and Advisors (an Independent Member of DFK Canada)
Subsection 164(1) of the Income Tax Act gives the Canada Revenue Agency (“CRA”) the ability to deny paying a refund where a tax return is filed more than 3 years after the applicable taxation year. This can result in some unforeseen tax consequences.
First, where a corporation is claiming a dividend refund (a refund of the refundable dividend tax on hand “RDTOH”) as a result of paying a dividend, this is considered to be a refund, even though it may be applied against taxes owing. Generally, the penalty for late filing a corporate tax return is based on the taxes owing. A shareholder of a corporation may not think that there is any penalty for late filing a return because there is no balance owing. However, where there are taxes payable that are offset by a dividend refund, the taxes payable will be assessed, but the dividend refund will be denied if the return is filed more than 3 years after the tax year end.
In addition, the CRA has historically reduced the corporation’s RDTOH balance by the dividend refund even though the dividend refund was never received. After several challenges, the CRA’s position has now changed and they will no longer reduce the RDTOH account where the dividend refund is denied.
The second significant effect of subsection 164(1) results when a corporation ignores a request to file a corporate tax return by the CRA. Where repeated requests to file a corporate return are ignored, the CRA may issue an arbitrary assessment. Often this arbitrary assessment results in taxes owing that are higher than what the actual assessment would be. If the arbitrary assessment is ignored, the CRA could then garnishee the corporation’s bank account. If this happens, and the corporation then files the actual tax return for the year in question, and is due a refund of the amount garnisheed from their bank account, the CRA will deny such a refund because it relates to a tax year for which the return was filed more than 3 years after the year end.
These two scenario’s highlight the importance of filing your corporate tax returns on time, or there could be significant financial repercussions even where there may be no tax owing.
Registered Disability Savings Plan
Written By: Enzo Morini, MBA, CPA, CA
Williams and Partners (an Independent Member of DFK Canada)
Having a disability or caring for an individual with a disability can be emotionally and financially draining. The Canadian government, recognizing the need to assist in the future care of an individual with a disability, has created a vehicle for persons with disabilities and their families to save for the future. A Registered Disability Savings Plan (RDSP) is a savings plan that is intended to help parents, relatives and others save for the long term financial security of a person who is eligible for the disability tax credit.
Unlike other savings plans, there is no annual limit on contributions to an RDSP. However, the lifetime limit of contributions is $200,000 and no contributions can be made after the end of the calendar year in which the beneficiary attains 59 years of age.
Anyone can contribute to a specific RDSP as long as the holder approves the contribution amount in writing. Contributions made to the RDSP are not eligible for a tax deduction by the contributors; however, income and capital gains within the plan grow on a tax-deferred basis. Once the funds are withdrawn, the amount is taxed as income in the hands of the beneficiary. Withdrawals include a blend of taxable and non-taxable amounts. Money that has been contributed to the RDSP is not included as taxable income when it is withdrawn. The amount of non-taxable income is calculated according to a formula developed by the Canada Revenue Agency. However, investment income and capital gains, plus any additional grants received and included in the plan assets, are included in the beneficiary’s income for tax purposes when paid out of the RDSP.
An RDSP can be opened for a beneficiary who is a Canadian resident, who is eligible for the disability tax credit, has a valid social insurance number and is currently under the age of 60. If the beneficiary is 59, the plan must be opened before the end of the calendar year in which the individual turned 59.
The program allows only one RDSP per beneficiary and only one beneficiary per RDSP.
Canada Disability Savings Grant as a Part of the RDSP
The federal government will assist saving for the beneficiary of the RDSP by providing matching grants of up to 3 dollars for every dollar placed into the account by contributors. The maximum grant provided through the Canada Disability Savings Grant (CDSG) is $3,500 per year and has a ceiling of $70,000 during the matching contribution period that ends when the beneficiary turns 49 years of age.
As can be expected, grant amounts are based upon the beneficiary’s family income and inflationary factors but, if taxpayers meet the various criteria to apply for the grants, the grants to the RDSP are as follows: (based on 2016 thresholds).
If family income is less than or equal to $90,563:
If family income is greater than $90,563:
Canada Disability Savings Bond as a Part of the RDSP
The government also contributes funds to low- and modest-income Canadians through the Canada Disability Savings Bond (CDSB). Those who qualify can receive up to $1,000 per annum to a maximum of $20,000, depending upon family income. The government will not make any further contributions after the year in which the beneficiary turns 49. In addition, it is possible to receive the bond even if contributions are not made to the RDSP.
Withdrawals & Repayments
As discussed above, a portion of withdrawals are taxable.
Because RDSPs are designed as long-term plans, a withdrawal of funds made within 10 years of receiving CDSG or CDSB assistance triggers CDSG or CDSB repayment requirements. Plan holders should be aware that the death of the beneficiary or a determination that the beneficiary may have a shortened life expectancy will create withdrawal or repayment requirements.
Because withdrawals or the death of the beneficiary will create different repayment or settlement terms, the beneficiary should seek advice to understand the financial and income tax impact of early withdrawal, death or shortened life expectancy.
Transfer Pricing Studies The Cost of Non-Compliance
Written By: Justin K. Hoffman, CPA, CA, CPA (Illinois), CFP, TEP, B.Comm
Senior Manager, Cross-Boarder Tax Services, Davis Martindale LLP (an Independent Member of DFK Canada)
While transfer-pricing studies are a reality of international business for large corporations, for small businesses a transfer pricing study may be prohibitively expensive to their organizations. For both Canadian and U.S. tax purposes, transfer-pricing penalties occur when contemporaneous information has not been prepared to document the determination of arm’s length prices for transactions between non-arm’s length parties. The following summary provides an insight into the Canadian and U.S. penalties associated with failing to maintain contemporaneous information.
Transfer-pricing penalties are triggered when the total of all transfer-pricing adjustments exceeds the lesser of:
If the penalty threshold is exceeded, the penalty for failing to maintain contemporaneous information is equal to 10% of the total transfer-pricing adjustment.
In quantifying the Canadian penalty please note:
Unlike in Canada, the U.S. transfer-pricing penalties are assessed on the underpayment of tax that results from the transfer-pricing adjustment rather than being assessed on the adjustment itself.
A 20% penalty will occur in two scenarios:
If the IRS determines that there has been a gross misstatement (based on specific numerical thresholds), the assessed penalty will increase from 20% to 40% if the adjustment is more than double the normal thresholds.
In estimating the U.S. penalty, please note:
The following example illustrates the potential application of Canadian and U.S. transfer pricing penalties:
For simplicity, assume that the Canadian dollar and U.S. dollar are at par. Canco has $3,000,000 in annual sales and purchases $1,000,000 in product from a U.S. subsidiary (“Subco”). The U.S subsidiary sells $3,000,000 of products worldwide. The tax authorities determine the transfer price on the intercompany sale should be $2,000,000. Accordingly, penalties result as follows:
Since the $1,000,000 adjustment is more than the 10% gross revenue threshold ($300,000), a 10% penalty is assessed on the $1,000,000 adjustment resulting in a penalty of $100,000 being assessed to Canco.
Since Subco has $3,000,000 in gross revenues, the threshold for the 20% net-adjustment penalty will be $300,000 and the penalty will increase to 40% if the adjustment is in excess of $600,000. Since the adjustment is $1,000,000, the 40% net-adjustment penalty is assessed on the underpayment of tax. Assuming a 35% tax rate, the underpayment of tax is $350,000 resulting in a penalty of $140,000 to the Subco. Since the net-adjustment penalty results in the largest penalty, the IRS does not assess any transactional penalties.
Changes to the Principal Residence Exemption Reporting
Written By: Enzo Morini, MBA, CPA, CA
Williams and Partners (an Independent Member of DFK Canada)
The principal residence exemption allows for all or part of the realized capital gain on the sale of a taxpayer’s principal residence to be tax free. For the purposes of the principal residence exemption, the Canada Revenue Agency defines the taxpayer to be a family unit consisting of the taxpayer, their spouse and any unmarried minor children. The CRA permits a family unit to designate one residence as their principal residence for any given year. Families with one home would have only one principal residence which means they would get full exemption from tax on any capital gains.
Until recently, the CRA did not require a taxpayer to report the sale of their principal residence on their income tax and benefit return. Unlike the sale of a property not classified as a principal residence where the capital gains realized would be reportable and taxable, the sale of a residence designated as the principal residence was exempt from tax reporting and from inclusion of any capital gain or loss into income or as a deduction. However, on October 3, 2016, the Canadian Government announced administrative and legislative changes to CRA’s reporting requirements for the sale of a principal residence. Starting with the 2016 tax year, a taxpayer will be required to report basic information related to the sale of their principal residence. The minimum information that will need to be reported includes the year of acquisition, the proceeds of disposition, and a description of the property sold. In some cases, the principal residence exemption does not cover all of a taxpayer’s capital gain on the sale of their home. In those cases, additional information must be provided to determine the full amount of the gain and the portion of the gain that is exempt.
These changes only impact the reporting of the sale of a principal residence and do not change the tax exemption associated with the sale of a principal residence. However, not reporting the sale of a principal residence could be costly. The normal time limits on reassessments no longer apply to unreported real estate sales. CRA can reassess an unreported real estate sale at any time. CRA has the discretion to accept or reject a principal residence exemption claim that is not filed as part of the original tax return for the year of the sale.
These changes also apply to transfers of a principal residence other than a sale; for example a gift to a child, or a bequest under a Will.
The information provided in this publication is intended for general purposes only. Care has been taken to ensure the information herein is accurate; however, no representation is made as to the accuracy thereof. The information should not be relied upon to replace specific professional advice.