Understanding Canadian Tax Law:  Weekly Tips and Techniques for Iran Javan

By: Bobby B. Solhi, Tax Lawyer

This week I will discuss an issue in tax law that affects many people who own a house/condo/town house and live there as their home. In our tax law in Canada, when someone owns capital property (like real estate), at the time it is sold, there is a taxable  event. For example, if you purchased the property for $500,000 and sold it for $750,000 there is a $250,000 profit that must be included in your income. For real estate, we
normally only tax 50% of the profit, so the taxable amount of income for the seller would  be $125,000 (250,000/2). Depending on your tax rate, you would be required to pay anywhere between approximately $33,000 to $59,000 in taxes.

For most people, they will own real estate like a house or condo and live in the property with their family as a home. For income tax, the profit you make on your home – also called your principal residence – is tax-free. This is called the “principal residence exemption” which makes the profit on your home tax-free. This exemption is claimed in the year that the property is sold. However, the concept seems simple but it can get
very complicated.

Tax tip #1: profit on the sale of real estate that is your home is normally tax-free.

What is meant by principal residence?

In general, a principal residence is house, condo, or townhouse that is owned by you alone or with your spouse and is live in by you, your spouse or former spouse or your children in the years you own it. You are only allowed one principal residence for tax purposes. So, if you own two properties like a home and a cottage you will be required to pick one of those properties to get profit tax-free. Also, it is possible, for example, for you not to live in the home and still claim it as your principal residence if your children lived there during the year.   A common question that is asked about this exemption is – how long do I have to live
there for it to be my principal residence? There is no set time by law. The Canada Revenue Agency is the government agency responsible for enforcing the tax laws in Canada. Their policy is to review your intention and other factors when you purchased the property and how you acted once you moved in. There are cases where a taxpayer lived in a house for a very short time and was allowed the principal residence exemption
because they were able to demonstrate that they lived at the house as their home and treated it like their home before they sold it.

Tax tip #2: you can only claim tax-free treatment on one home per year.

What happens if the CRA does not allow my sale of home as tax-free?

There are many cases where a person will purchase real estate and sell it a short time later for a profit. If this is their home, then it is possible to claim the principal residence exemption and make the profit tax-free. However, the CRA has been aggressive in recent years by reviewing these sales and asking the seller to provide evidence or proof that the real estate was their home (or principal residence) and that the profit is tax-free.

In many cases, the CRA will disagree and instead find that the profit was taxable. Sometimes they will treat it as a capital gain to the seller, which means that they would be required to include 50% of the profit into their income – or, in more extreme cases – they will say that the profit on the sale was business income. If they determine it is business income, than the entire profit will be included into the sellers income and is
taxable.

There are many ways to ensure that when you purchase or sell real estate that it is done on a tax efficient basis. Proper documentation and making the right arguments based on law are fundamental to defending your profits from tax.

This article is for informational purposes and does not constitute legal advice.

February 7, 2013

What is the best way to structure your business?

There are three common ways to organize your business: 1) sole proprietorship; 2) partnership; and 3) corporation.  When deciding which structure to use for your business, there are some important factors that should be considered before proceeding.  I will spend some time discussing the basics of the business and tax reasons for each briefly.

1)      Sole proprietorship

This is the simplest way to operate your business.  You simply register a business name and the ownership of the business is held in the name of one person – most times the owner is also the operator of the business.  From a corporate law perspective, a sole proprietor is personally liable for any debts of the business.  For example, Mr. S operates a delivery business.  He buys materials to deliver but is late in making his payments to the supplier.  He will be personally liable for those amounts, which means that the supplier (or creditor) could go after his house and other personal property to make sure they are paid.

From a tax perspective, a sole proprietorship can be very good depending on your circumstances. For example, if the individual owner expects to lose money the first year, then those losses can be used to reduce their tax from 3 previous years or future years.  Those losses can also be used to reduce tax from rental income and other types of investment income.  However, if you expect your business to make significant profit the first year, then this may result in more tax than using a corporation, which I will discuss below.

2)      Partnership

A partnership is a way to do business where two or more people are in business for the pursuit of profit.  It is possible to have a partnership with an agreement but it is highly recommended that you have a lawyer draft a partnership agreement if you intend to do business as partners.  For our clients, we will draft the partnership agreement so that there is no confusion as to how much each partner owns in the business and their responsibilities.  Like a sole proprietorship, each partner in a partnership is liable for the debts of the business.  Your personal assets may be attacked if there are financial problems down the road.

From a tax perspective, a partnership can be good to split income from the business between the partners and reduce your tax liability.  If you have losses from other business or investments in previous years, you can use them to reduce your income from your partnership income.  For example, if you and your spouse are partners then the income from the business will be split between the two people instead of all the income going to one person.  If it is goes only to one person, like a sole proprietorship, then the tax rate will be very high for that person.

3)      Corporation

A corporation is a separate person for legal purposes.  This means that if you form a corporation, for example, Business Inc., then Business Inc. is its own person and any income and liability is attributable to that entity.  If you would like a corporation, it is very important that you have a lawyer incorporate for you.  There are many requirements that most non-lawyer’s do not know about.  For corporate law, a corporation is liable for any debts incurred by it.  So, if the corporation is in the business of wholesaling materials and does not pay its suppliers, then the suppliers can only go after the corporation.  The owners of the corporation will be shareholders and are only responsible for the amounts they invest in the corporation.  The personal property of the shareholders are normally protected from creditors.

From a tax perspective, a corporation will normally pay 15.5% on its business income up to $500,000 per year.  This is a very good tax rate.  For a sole proprietor or partnership, the tax can go as high as about 47%.

This article is for information purposes only.  This is not legal advice.  Please contact us to learn more. 

 

January 15, 2013

HST Rebate on New Homes

There is a topic that I think will be very helpful to discuss in this week’s article:  HST rebate on New Homes.  I am helping many clients who have received a letter from the Canada Revenue Agency (CRA) asking that they repay amounts for HST rebates that they received on their purchase of a new home.  The CRA will send a Notice of Reassessment and request repayment of usually $24,500 to $35,000.  I will explain what this is all about and discuss options for those with this issue.

In Ontario, a purchaser of a new house, condominium, town house, or other type of home must pay 13% HST on the purchase price of the home.  Of the 13%, 5% goes to the federal government and 8% goes to the Ontario government.  For example, if you purchased a pre-construction house for $700,000 you are required to pay $91,000 in HST of which $35,000 goes to federal government and $56,000 goes to the Ontario government.  Ontario gives a purchaser of a new home a rebate of up to $24,000 on the HST.  However, and this is very important, they will only allow the rebate if the home was purchased for use as a principal residence – this means that you purchased the home for you or your family to live in.  Not investment properties. If the house was purchased as a home, then the rebate will be applied against the HST amount owing.   This refund is usually cashed in by the builder so that you do not actually see the rebate.  All that the purchase sees is the outstanding amount of the HST, which in this example would be $67,000.  Normally when you get a mortgage to buy a home, the mortgage will cover the costs of the HST.

Tax Tip #1:  Ontario gives a $24,000 HST refund only when house is purchases as you home, not investment.

 In many cases that I work on, the client will be contacted by the CRA auditor who will ask them about their purchase of a house, condo, or town home and ask that they send purchase and sale agreements plus other documents to the CRA to review.  This is a good time to speak with a tax lawyer.   What the CRA is trying to do, in most cases, is determine whether you purchased the property to occupy it as your home.  Most of the staff from CRA do not really understand how this law works and will, even after you given them your explanation and documents, send a letter demanding that you pay the HST rebate back to the government.  They will also charge interest and sometimes penalties.

Our next step with this type of file is to prepare and file a Notice of Objection to the CRA.   As a tax lawyer, I will draft the legal documentation and organize your various documents to present a nice, clean case to the CRA.  The objection is then sent to the appeal’s division of the CRA where a new CRA officer will review the case and contact us to discuss the case further.   It is normally at this point that the CRA officer will decide whether to agree with you and cancel the demand for payment or, if they do not agree, we can take your case to the Tax Court of Canada.   In my experience, most cases do not go past the objection stage and almost all are settled before Tax Court.  However, where it is required, we will go and argue the case before the Tax Court judge.

 Tax Tip #2:  If you disagree with the CRA, you have the right to file an objection and plead your case.

 If you would like to learn more, please feel free to contact us.

Mr. Bobby (Behzad) Solhi, Barrister & Solicitor, TaxChambers LLP, (416)847-7300, bobby.solhi@taxchambers.ca.

 

 

January 10, 2013

Benefits of Professional Corporation

In Ontario, there are certain licensed professionals that can operate their business through a corporation instead of personally and save a significant amount of tax on their income.  These professions include accountants, architects, dentists, physicians, engineers, lawyers and paralegals, chiropractors, pharmacists, and veterinarians.

For these professionals, there is an opportunity to form a professional corporation and reduce your taxes and re-invest those savings with less tax.  There are many benefits to a professional corporation that make it a must for many professionals but it is important to keep in mind that a corporation is only a good step when your make enough money to save.  If you need every penny you earn to pay for your monthly living expenses, then there would be no benefit for you at that time.  As professionals develop their business and earn, usually, over $115,000 per year, then we find that is a good time to set up a professional corporation.

Tip# 1:  A professional corporation is not always the right structure if income is low

Professional corporations are different than a regular corporation.  There are special rules that apply to a professional corporation that do not exist for regular corporations.  Each professional college like the College of Surgeons and Physicians must provide special permission for the doctor to establish a corporation plus additional documentation must be included to qualify.

Professionals cannot operate through a regular corporation.  If they do, there could major penalties to them.

Tip#2:  A professional corporation is different than a regular corporation

The regular tax rate for high income earners can be as high as 47.97% in Ontario in 2013.  With a professional corporation, those eligible professionals can reduce their tax liability to only 15.5% with a professional corporation as long as that income is held in the corporation.  The savings can be used to pay for business expenses and make investments.   If they want to take money out of the corporation there are many ways, one of which is to pay salaries and other payments, like dividends.

When a professional is ready to retire, they can sell their shares in a professional corporation tax-free up to $750,000 as part of their lifetime capital gains exemption.

If you are an eligible professional, please contact me to learn more.

Mr. Bobby (Behzad) Solhi, Barrister & Solicitor, TaxChambers LLP, (416)847-7300, bobby.solhi@taxchambers.ca.

 

TaxChambers LLP is collaborating with Andersen Global® in Canada.