employment income would be earned for tax purposes [ITA 7(1)]:
Value of shares on purchase date (1,000 x $10) $10,000 Cost of shares acquired (1,000 x $8) (8,000)
Employment Income $ 2,000 In 20X3, the year the shares are sold -
Selling price (1,000 x $14) $14,000 Value of shares at purchase date (1,000 x $10) (10,000)
Capital Gain $ 4,000 Taxable capital gain (1/2) $ 2,000
2. Since the option is not in the money at the grant date (i.e., the option price is not less than the grant date value), in 20X0, one-half of the employment income from the stock option (1/2 x $2,000 = $1,000) can be deducted from net income in computing taxable income as a
stock option deduction [ITA 110(1)(d)].
3. If the employer was a Canadian-controlled private corporation the answer in part 1 would change in two ways:
a. The timing of the recognition of the stock option benefit for tax purposes. The employment income of $2,000 [(1,000 x $10) – (1,000 x $8)] is included in the taxpayer’s 20X3 income for tax purposes (the year the shares were sold) rather than in 20X0 (the year the shares were acquired) [ITA 7(1.1)].
b. The stock option deduction. Because the employee held the shares for at least two years, when computing taxable income in 20X3, one-half of the employment income from the stock option (1/2 x $2,000 = $1,000) can be deducted as a stock option deduction [ITA 110(1)(d.1)].
Note that the taxable capital gain, in this case, may be eligible for the capital gains deduction as the shares may be qualified small business corporation shares if all or substantially all of the corporation’s assets are used in an active business [ITA 110.6(1)].
PROBLEM FIVE
[ITA: 5(1); 6(1)(a), (b), (c), (e), (g), (k); 6(2); 7(1); 6(9); 80.4(1); 7(1), (8); 110(1)(d); IT-470R] Carol Posh is a senior advertising executive with a large Winnipeg company. With winter fast approaching, Posh is seriously considering an offer of employment from Westcoast Promotions Inc. (WPI), a large public company in Vancouver. Although housing costs are high in Vancouver, the climate and opportunities for career advancement would be better.
Posh has received a letter outlining a proposed remuneration package. The package is attractive but she is uncertain of the tax consequences. She has asked you to advise her. WPI recognizes the problem of housing costs and begins its letter with an offer to loan Posh $150,000, interest-free, to help finance a new house. In addition, WPI will reimburse her for 75% of her moving costs. In addition to an annual salary of $120,000, WPI has offered the following benefits:
1. Posh will be appointed a director of the company’s American subsidiary in California; this will require her to travel to Los Angeles three times a year for board meetings. Posh will be paid a director’s fee of $5,000 directly from the American company. Company policy permits spouses to take these trips as well. When a director takes his or her spouse, all travel expenses are paid for by the company.
2. A luxury automobile will be provided for her personal use, even though she will never require the car for business. The company will pay all of the operating costs—approximately $3,200 per year—as well as the monthly lease cost of $850. Posh will drive the car approximately 20,000 kilometres per year.
3. WPI will include Posh in its group term life insurance program and pay the premium, which provides coverage for $75,000. It will also pay the premiums for a private health plan, a dental plan, and a drug plan.
4. The company has a deferred profit-sharing plan, for which Posh will qualify. The maximum contribution will be made to this plan only when the company’s profit for the year is greater than 12% of the stated balance sheet equity.
5. Posh will be eligible for an annual bonus of up to $40,000, with the actual amount to be based on her productivity. The bonus will be awarded on November 30 of each year (the company’s year-end) but will not be paid until May 31 of the following year. Of the above- mentioned bonus, 25% will be retained in an employee benefit plan for five years. The investment income earned by the plan will be distributed to Posh each year.
6. WPI will provide Posh with a monthly allowance of $800 to cover any expenses she may incur. In addition, she will be reimbursed for travel costs to attend the annual advertising convention in Paris.
7. All WPI employees are entitled to participate in a stock-option plan. The available shares are non-voting but do participate fully in profits. The option price is $12 per share; this price is guaranteed for three years and will then increase to $14 per share. Currently, the shares are trading at $12 per share; they are expected to rise significantly within two years.
8. Posh will be provided with club memberships in the “better” social clubs in the area for relaxation purposes. This will help her be more productive in her work.
Required:
Prepare a brief report for Posh.
Solution to P4-5
The issues that should be reviewed in the report are summarized below: Interest Free Loan:
Creates a taxable benefit annually equal to the amount by which the prescribed interest on the loan exceeds the actual interest paid on the loan by 30 days after the end of the year [ITA 80.4(1); 6(9)]. Because the loan is interest-free the benefit is equal to the prescribed interest.
Since the loan will be used by Posh to buy a home, the prescribed rate used to calculate the taxable benefit, for five years, will not exceed the prescribed rate in effect at the time the loan is made [S.80.4(4)]. S.80.4(6) deems the loan to be renewed every five years.
Since Posh will have an eligible relocation, the loan qualifies as a home relocation loan and, thus, Posh will be entitled to a deduction in computing her taxable income for the first five years of the loan effectively equal to the prescribed rate applied to a $25,000 loan [S.110(1)(j)].
The loan to Posh will be a "home relocation loan” [ S.248(1)], because: Posh will commence work at a new work location in Canada
she will move from a former residence to a new one
the move will bring her at least 40 kilometres closer to her new work location (measured as the difference between the distances travelled from the new work location to each of the old and new homes)
the loan will be received in her capacity as employee
the loan proceeds will be used to buy a home to be occupied by her the loan will be designated by her as a home relocation loan, and
there will be no other “home relocation loans” in connection with the move or outstanding at the time.
The home relocation loan deduction is calculated under S.110(1)(j) as the least of: the imputed interest benefit on the home relocation loan
$25,000 x the prescribed rate
the imputed interest benefit on all loans from her employer
The deduction is available for the first five years of the loan, or for the period to the date the loan is extinguished, if shorter.
Reimbursement of Moving Costs:
Although this is a benefit, it is not considered to be taxable by administrative policy [IT-470R]. Director’s Fee from US Company:
Is fully taxable as employment income [ITA 6(1)(c)]. As a resident of Canada, Carol is taxable on her world income.
Amounts Paid for Spouse Travel:
Is a taxable benefit to Carol Posh under the general rule that benefits of any kind whatever are
taxable as employment income [ITA 6(1)(a)]. Automobile for Personal Use:
Both an operating and capital benefit will result:
ITA 6(1)(k) Operating benefit 20,000 km x 24¢ $ 4,800 ITA 6(1)(e) Capital portion (standby charge):
ITA 6(2) 2/3 x $850 x 12 months 6,800 $11,600 Life Insurance Premium:
The full premium paid by the employer is a taxable benefit [ITA 6(1)(a)]. Private Health Plans:
Although a benefit, private health plans are specifically excepted and are not taxable [ITA 6(1)(a)]. Contribution to DPSP:
By exception to the general rule on benefits, DPSP contributions are not taxable when they are contributed to the plan [ITA 6(1)(a)(i)]. Both the contributions and the investment returns on the contributions remain not taxable until the year in which they are paid out to Posh.
Bonus Plan:
Employment income is recognized for tax purposes on a cash basis when received [ITA 5(1)]. In this case, 75% of the bonus will be taxable in the year following the award. The remaining 25% paid into the benefit plan will be taxable to Carol when it is paid out of the plan after five years [ITA 6(1)(g)]. The annual interest earned from the benefit plan is taxable annually as received [ITA 6(1)(h)]. Allowance:
The allowance does not appear to be for any specific use (e.g., travel, etc.). Therefore, by the general rule for employment income the allowance of $9,600 annually is fully taxable [ITA 6(1)(b)]. Reimbursement for Travel:
Assuming that the convention is attended on the company's behalf, the reimbursement is not a taxable benefit.
Stock Option:
Carol will receive an employment benefit equal to the amount by which the fair market value of the stock at the purchase date exceeds the price paid for the stock as stipulated in the option agreement. Because the $12 option price is not less than the stock’s market value when the option was granted, Carol can deduct a stock option deduction, equal to one-half of the employment benefit, from net income in computing taxable income [ITA 110(1)(d)].
If the option is exercised immediately, the taxable benefit is NIL per share (FMV of $12 minus the cost of $12). If the stock grows in value after the purchase, a capital gain (of which one-half is taxable) will occur in the year the stock is sold.
If Carol delays the purchase, as is her right under the option agreement, and the stock continues to rise in value as predicted, a greater amount will be included as employment income when the stock is eventually purchased and a lesser amount of capital gain will result on sale. However, because Carol qualifies for the stock option deduction in computing her taxable income, delaying the exercise date changes the nature and timing of the income inclusion but not the amount taxable.
Club Dues:
Club dues paid by an employer are considered to be a taxable benefit under the general rule for the tax treatment of benefits [ITA 6(1)(a)]. By administrative policy it will not be considered as a taxable benefit if it can be shown that the membership is principally for the employer's advantage [IT-470R]. In this case it does not appear to be so; thus, the benefit is taxable.
PROBLEM SIX
[ITA: 5(1); 6(1)(a), (b), (k), (e); 8(1)(f), (i), (m); 8(2); IT-470R]
Paul Fenson is employed as a shipping supervisor. In the evenings and on weekends, he holds a second job as a real estate salesman for a national real estate firm. His financial information for 20X0 is as follows:
1. His salary from his day job is $30,000 per annum. However, the employer deducts a number of items from his salary, and so his net take-home pay is only $20,400. The following amounts were deducted in 20X0:
Income tax $ 3,900 Union dues 600 Canada Pension Plan 1,310 Employment Insurance premiums 560 Registered pension plan contribution 3,000 Reimbursement for personal use of employer’s car 600 Charitable donations remitted to United Way 800 $10,770 The employer paid the following amounts on behalf of Fenson:
Canada Pension Plan $ 1,310 Employment Insurance premiums 790 Registered pension plan 3,000 Premiums for a mandatory provincial health insurance plan 600 Group term life insurance premiums ($50,000 coverage) 1,200 $6,900
Fenson used the employer’s summer camp for a one-month holiday and paid the employer $200 rent. When not being used by employees, the summer camp is rented for the normal amount of $600 per month.
Although Fenson owned his own automobile, he was provided with a company car. The car cost the company $23,000. During the year, he drove a total of 20,000 km, of which 14,000 was for personal use. The employer also paid all of the operating costs, which amounted to $3,000.
During the year, Fenson attended a shipping conference in Toronto. His wife travelled with him at the company’s expense ($1,000). The employer permitted staff to purchase merchandise from its retail outlet at the company’s cost. During the year, Fenson purchased for $800 merchandise with a retail value of $1,200.
2. As a real estate salesman, Fenson earned a base salary of $8,000 and received commissions of $7,000. In relation to his real estate work, he incurred the following expenses:
Dues to a local real estate association $ 400 Fee for a three-day seminar on how to be an effective salesperson 800 Advertising—calendars and pens 1,700 Automobile operating costs 4,000 Promotion (meals and drinks for clients) 2,800 Personal meals (during in-town business) 400 Purchase of a portable telephone 2,000
Fenson used his own automobile for his real estate activities. The car has an undepreciated capital cost for tax purposes of $10,000. During the year, he drove a total of 30,000 km, of which 27,000 was related to selling real estate. His employer provided him with a monthly car allowance of $200 ($2,400 per year).
Required:
Solution to P4-6
Fenson's income from employment is as follows: Items of Income:
ITA 5(1) Salary - Day job $30,000 ITA 5(1) Salary – Real estate salesman 8,000 ITA 5(1) Commissions - Real estate salesman 7,000 Benefits:
- ITA 6(1)(a) Provincial health insurance premium (Note 1) 600 - ITA 6(1)(a), 6(4) Group term life insurance 1,200 - ITA 6(1)(a) Summer camp ($600 - $200) 400 - ITA 6(1)(e), 6(2) Automobile - standby charge
2% x $23,000 x 12 months $5,520 - ITA 6(1)(k) Automobile operating expense benefit
24¢ x 14,000 personal km 3,360
Less reimbursement paid to employer (600) 8,280 - ITA 6(1)(a) Spouse's travel costs 1,000 - ITA 6(1)(b)(v) Travel Allowance (Note 2) 2,400 58,880 Deductions from Income:
ITA 8(1)(m) Registered pension plan contributions (RPP) $3,000 ITA 8(1)(i) Union dues 600
Sales expenses (Note 3) 9,700 (13,300) Employment income $45,580 (Note 1)
The public medical insurance plan premium was included as a benefit because it was assumed that the employer's contribution was not mandatory. It would not be taxable if the employer was required by law to pay a portion of the premium (such as an employer health tax).
(Note 2)
The car allowance of $200 per month received from the real estate employer is deemed not to be a reasonable allowance since it is not based on the number of kilometers for which the car is used for employment purposes [ITA 6(1)(b)(x)]. Therefore, the allowance is taxable [ITA 6(1)(b)(v)]. Because the allowance is taxable, it permitted the taxpayer to deduct the numerous expenses incurred to earn the commissions. If the travel allowance had been reasonable, the $2,400 would be excluded from income but the $9,700 of employment expenses would then not be permitted as a deduction, and Fenson's net income would increase accordingly [8(1)(f)(iv)].
(Note 3)
Expenses relating to real estate sales: ITA 8(1)(f) Limited expenses:
Dues to real estate association $ 400 Advertising 1,700 Automobile operating costs
27,000 km/ 30,000 km = 90% x $4,000 3,600 Promotion – meals & drinks (50% of $2,800) 1,400 $7,100
Limited to a maximum of commission earned $7,000 Non-limited expenses:
ITA 8(1)(j) Capital cost allowance
$10,000 x 30% = $3,000 x 27,000 km/30,000 km 2,700 $9,700 (Note 4)
The following items were excluded from income:
Company portion of Canada Pension and Employment Insurance premiums. These items are a tax on the employer.
Company RPP contributions are specifically exempted [ITA 6(1)(a)(i)].
Merchandise discounts. Under CRA’s administrative policy discounts offered to all employees (but normally not below the employer’s cost) are considered non-taxable [IT- 470R].
The following expense items were not deducted:
Canada Pension Plan, Employment Insurance premiums, and charitable donations are not deductible because they are not specifically exempted from the general rule that no deductions are permitted. Each of these items, however, is eligible for a tax credit (Chapter 10).
Fees for a three day seminar on becoming an effective salesperson. The permitted salesperson's deductions do not include any expenditure of a capital nature. The seminar will provide a long term benefit to Fenson and, therefore, is a capital item [ITA 8(1)(f)(v)]. Meals (in town). The deduction of personal meals is only permitted when traveling outside
of the municipality in which the employer is located and when the taxpayer’s duties require the taxpayer to be away for 12 hours or more [ITA 8(4)].
Portable telephone. This is a capital item because it has a long term benefit and therefore is not deductible [ITA 8(1)(f)(v)].
PROBLEM SEVEN
[ITA: 5(1); 7(1); 8(1)(i),(m); 8(4); 8(13); 38; 40(1)]
Riley Fontaine has requested that you review the calculation of his 20X1 net income for tax purposes. He has provided you with the following information:
1. His salary consists of the following:
Basic salary $92,000 Bonus 6,000 $98,000
The bonus of $6,000 was awarded to him on December 31, 20X1, and was paid on January 15, 20X2.
2. His employer deducted the following items from his salary and remitted them to the appropriate party on his behalf:
Canada Pension Plan $2,217 Employment Insurance premiums 787 Registered pension plan 4,400 Income tax 26,000 Charitable donations (United Way) 3,500
3. Fontaine is employed by Remco, a Canadian public corporation. Two years ago, Remco granted Fontaine an option to purchase 1,000 of its common shares at $16 per share. At the time the option was granted, Remco’s shares were trading at the same value of $16 per share. On January 31, 20X1, Fontaine purchased 1,000 shares of Remco (trading value at purchase date—$22 per share). On November 30, 20X1, he sold all of the shares at $24. 4. Remco requires that Fontaine work out of his home from time to time. Remco has supplied
him with a computer and modem for this purpose; however, Fontaine must pay for his own supplies. His house is 2,000 square feet and his workstation is a room of about 200 square feet. He also uses the room as a den and guest room. Utility costs for his home for 20X1 amounted to $1,200.
5. Fontaine travels out of town from time to time to his employer’s manufacturing plant. Remco reimburses him for all travel costs, except meal costs. The plant is only 90 km from the head office, and he always returns home the same day after working a normal eight-hour day.
6. Fontaine has calculated his net income for tax purposes as follows:
Employment income
Salary and bonus $98,000
Deductions
Registered pension plan 4,400 Employment expenses:
Meal costs while out of town: $300 50% 150 Office at home:
Minor repairs 340 Utilities (200/2,000 x $1,200) 120 Office supplies and stationery 410 Computer software (word processor)
220 92,360
Capital gains (Remco shares)
Selling price (1,000 x $24) $24,000 Cost (1,000 x $16) 16,000 Gain 8,000 Taxable (1/2 of $8,000) 4,000 Net income $96,360 Required:
Advise Fontaine whether his calculation of 20X1 net income for tax purposes is correct. If it is not, recalculate a revised 20X1 net income for tax purposes, and briefly explain the changes you made.
Solution to P4-7
The revised net income for tax purposes is: Employment:
Salary [ITA 5(1)] $92,000 Stock option benefit [ITA 7(1)]:
value at purchase date ($22 x 1,000) $22,000
option purchase price ($16 x 1,000) 16,000 6,000 98,000 Deductions from employment income:
Pension contribution [ITA 8(1)(m)] (4,400) Office supplies [ITA (8(1)(i))] (410) 93,190 Capital gain (Remco shares) [ITA 40(1)]:
Proceeds ($24 x 1,000) $24,000 Adjusted cost base ($22 x 1,000) (22,000) Capital gain $ 2,000
Taxable gain ($2,000 x ½) [ITA 38] 1,000 Net income $94,190 Summary of changes:
1. The bonus was excluded - it was not received in 20X1. Employment income is taxed on a cash basis, therefore the bonus is included in employment income in 20X2, the year received [ITA 5(1)].
2. The capital gain on the stock option shares should be calculated as the excess of the proceeds over the value of the shares at the time they were acquired [ITA 53(1)(j)]. The excess of the value at the acquisition date over the purchase price is employment income [ITA 7(.1)]. Because the option price was not less than the share value at the date the option was granted, a stock option deduction of $3,000 (½ x $6,000 employment benefit) can be claimed when arriving at taxable income [ITA 110(1)(d)].
3. The home office expenses (repairs of $340 and utilities of $120) were excluded because Fontaine does not meet either of the two tests in ITA 8(13) –
1) the home office is not the place where he principally performs his duties of employment. (He is required to work from his home from time to time.)
2) the office was not used exclusively for employment purposes and was not used on a regular basis for meeting customers or other persons in carrying out his duties of employment. 4. The cost of meals incurred as a travel expense ($300) was excluded because the daily trips were
less than 12 hours [ITA 8(4)].
5. The computer software ($220) was excluded because there is no provision in section 8 for such a deduction. It is also a capital item. ITA 8(1)(j) & (p) permit an employee a CCA deduction on a car, an airplane and a musical instrument, only.