From time to time in a tax practice you come across issues which give you cause to stop and think. After you stop and think you then want to share the stories with others so that the errors can be avoided. Here are a few issues which have come across my desk in the last little while that are worth sharing,

Personal/Business Expenses

For small business owners the lines between the business life and personal life are often blurred. Family members may help out in the business, the same truck may be used for hauling the boat trailer and business equipment, and trips will often combine business and pleasure. Unfortunately, when CRA’s vision is blurred they don’t often see things the taxpayer’s way. As a result, expenditures which are claimed by the business may be denied on account of the personal element.

In general terms, expenses will only be deductible to the extent they were incurred to produce income. Accordingly, it is critically important in these circumstances to document your every move. You will want to describe in detail the services provided by family members and ensure that cheques are cut and delivered to the appropriate people. On trips that involve business activities make sure that those activities are described in detail so that the expenses can be allocated properly. The same thing applies for promotional activities such as dinners, golf dates or hockey games. You will want to take note of who you were with and in general terms what was discussed. A little bit of paper can go a long way.

Capital Gains Exemption

Most of us know and understand that there is a $500,000 capital gains exemption on qualifying small business corporation shares. There are a number of conditions which have to be satisfied, one of which is a 24 month holding period for the shares. There is an exception to this rule which is not as well known and that is where the shares are issued in exchange for the assets of a business carried on by the shareholder. An individual can therefore incorporate a sole proprietorship and then immediately sell the shares to claim the exemption. This can be very effective for owners of professional practices which have recently been allowed to incorporate.

A recent ruling by CRA would indicate that this exception to the 24 month holding period will be strictly interpreted. In that case the business was carried on by a company and the land on which the business was situated was owned by one of the shareholders. Prior to a sale of the company, the shareholder transferred the land to the corporation in exchange for additional shares. The shareholder sought to claim the exemption on those additional shares claiming that the land was an asset used in the business. The claim was denied because the business was not carried on by the shareholder but rather by the shareholder’s company.

The common thread in all of these is to look before you leap. Sometimes seemingly straightforward transactions can result in devastating tax consequences which in turn can be a source of additional costs and distractions. Seeking professional advice in advance is never a bad thing.

Residency

Canada’s entitlement to tax is generally based on residency. A Canadian resident is subject to tax in Canada on worldwide income. We typically think of residency issues arising between countries and there are treaties which are designed to address residency and tax issues between countries. More on that later. However, residency issues can also arise between provinces since the same rules apply. The right of a province to tax is also based on residency.

Here in the nation’s capital we are in a somewhat unique situation with a provincial boundary essentially bisecting the National Capital Region. There is significant mobility between the provinces as people move back and forth and perhaps own real estate in both provinces. Ownership of real estate is one of the factors that a taxing authority will look at to determine residency. I recently came across a situation where a person had moved from Ontario to Quebec, stayed for a few years and then moved back to Ontario. After returning to Ontario the person resumed filing and paying tax as an Ontario resident. Only problem was that because there was still a property owned in Quebec, Quebec wasn’t ready to give up its claim to provincial income tax. Now the taxpayer has paid tax in Ontario and is fighting a parallel claim from Quebec. Aside from legal costs there is still the potential that provincial tax will be paid twice. Moral of this story is to be very careful if you have ties to two or more provinces. You need to be certain that you have severed ties for tax purposes in the one before resuming tax status in another.

Similar issues apply internationally and often we are dealing with treaties to determine the tax entitlement of competing countries on such issues. If you intend to leave Canada on a permanent basis, you want to be certain that your tax status is clear. There is a form which the Canada Revenue Agency asks to be filled out to determine residency. It is not mandatory and professional advice should be sought on whether to, and how to, fill it out. The form is filled with questions which are designed to indirectly provide CRA with the foundation to assert that the person is still a Canadian resident under the applicable treaty. For example, a lifetime Canadian recently retired and chose to spend his retirement in a foreign country. He completed the form and because he was retired he indicated that he would not be subject to tax in the foreign country. This is a bright red flag to CRA and the determination was made that the person was still a Canadian resident. All because of a single answer to what appeared to be a straightforward question.