Audit Alert: Avoid Traps in Claiming Interest as a Carrying Charge

If you pay interest on money borrowed to earn investment income, you can claim a deduction for the interest paid as a carrying charge. That’s quite lucrative as the deduction offsets all other income of the year and can help to reduce net income, the figure upon which certain government benefits, like the Canada Child Benefit, are based.  But, the claim is not as straight-forward as you might think.

First, there must be a reasonable expectation that the invested funds will generate a return on the investment, in excess of the cost of borrowing the money – i.e. there must be a reasonable expectation that “income from property” can be from the investment. This means that the investment has the potential to earn interest, dividends, rent or royalties, which will be reported as income on the tax return. Despite the deduction, if you borrow money at 6% to invest in a property with an expected rate of return of 3%; you may not come out ahead.

With one exception – publicly traded shares that have the potential to earn income  – if the investment will only earn capital gains on disposition, then the interest paid on money borrowed to purchase the investment is not deductible as a carrying charge, although it may be added to the cost base of the asset to reduce the capital gains tax when the asset is disposed of. 

For interest paid on money purchased to earn income from a business, the interest is a business expense.

Where things get tricky is when the money borrowed cannot be linked directly to the earning of investment income. This can happen when the borrowed funds are used for both personal and investment purposes. A common example is the use of a line of credit for both investing and paying personal expenses. As much as possible, comingling of borrowings for personal and investment purposes should be avoided so that it is clear that the money borrowed was used to earn investment income.

CRA has provided an example of this in its Folio S3-F6-C1 Interest Deductibility:

“Assume an individual has a $100,000 line of credit. The individual uses $60,000 for personal purposes and $40,000 to acquire income-producing property. Accordingly, 40% of the line of credit is used for eligible purposes. Where a repayment of a portion of the borrowed money occurs, it will be necessary to apply this percentage to the remaining balance of the line of credit to calculate how much interest is deductible. If the individual makes a $20,000 payment, the balance on the line of credit will be $80,000. The individual cannot allocate the repayment specifically to the ineligible portion of the borrowing. Instead, applying the original eligible use percentage to the balance, interest on $32,000 of the borrowed money (being 40% of $80,000) will be deductible.”

Also of note is that a recent Federal Court of Appeal decision, in the case of  Van Steenis v. Canada. It upheld a decision by the Tax Court of Canada in a case where a taxpayer borrowed to invest in mutual fund units and subsequently received a return of capital from the mutual fund, some of which he then used for personal purposes. The court’s findings were that the funds originally used for investment purposes were no longer being used 100% for investment purposes and therefore the interest on the funds was no longer 100% deductible. The courts found that the return of capital was actually part of the money invested and, therefore, unless the return of capital was used to pay down the loan or to purchase other investments, the money borrowed was no longer being used to earn investment income. 

The take away for investors who borrow money to purchase mutual fund units is that, if they want to continue to deduct the interest paid on the money borrowed,  they must use any return of capital to either repay the money borrowed or they must re-invest it. This, of course, does not stop the investor from using any income earned on the funds for personal purposes.

Thought Leadership: A Secure Retirement for Seniors?

Running out of money or the inability to maintain a desired standard of living is a very familiar concern for most Canadians. It’s an issue that needs to be addressed, not only by the government, but also by wealth planners who have an opportunity to work with senior clients in overcoming the obstacles they face.

Seniors’ main retirement concerns stem from a few different fronts. Statistics show that the population of Canadians aged 65 and over is increasing. In 1999, the senior demographic made up 12% of the Canadian population.  In 2017 it rose to nearly 17%, and it’s projected to increase to 24% by 2036. This means that programs like CPP, GIS, and OAS will have a larger population to support, and fewer Canadians in the workforce paying into it. Increasing concerns further is the fact that, seniors’ debt load is at an all-time high. In 2016, the percentage of senior families with debt was 42%., 14% of senior families still hold mortgages, and consumer debt was at 37% in 2016. Heading into retirement with a debt load not only creates unease about the future, but also more to think about and prepare for in retirement.

Another issue: as Knowledge Bureau previously reported, as many as 10% of Canadian seniors fail to receive their Guaranteed Income Supplement (GIS), meaning these seniors are missing out on this important income stream in their retirement years. A clear concern for many seniors, as Statistics Canada reports that we could see more than 25% of the labour force made up of people aged 55 or older by the year 2036 – a choice to work later in life which is often motivated by concerns related to financial stability. Service Canada has also noted a few other concerns, including the fact that many Canadians do not know that they have to ask the government to deduct taxes from CCP payments and that when surveyed many Canadians did not know that CPP benefits and contributions were going up starting in 2019.   

And, an additional concern, identified by respondents to our March poll: 68% said that envisioning retirement is as difficult as saving for it.

How does the Finance Department intend to address these concerns? During an April 25 town hall, the Finance Minister indicated that “Every Canadian should feel good about what the future holds, and confident that support will be there when they need it.”  And that seniors, in particular, should feel assured that the Canadian government is investing in their retirement. Mr Morneau went as far to say that with the investments outlined in the 2019 Budget, Canada is doing more to “support seniors and help them enjoy a secure and dignified retirement, free of financial worries.”

A few of the proposed investments include:

  • Helping seniors who choose to work keep more of their earnings.
  • Creating more opportunities for seniors to be active in their communities.
  • Ensuring that eligible Canadians receive their Canada Pension Plan benefits.
  • Introducing new measures to better protect workplace pensions in the event of corporate insolvency; and
  • Create Canada’s first National Dementia Strategy. 

The proposed investments have also opened up further conversation focused on ensuring that everyone entitled to CPP receives it. To deal with this gap, the 2019 Budget has proposed to proactively enroll Canadians over 70 years of age.

But there are critics of the government’s efforts of pension reform in Canada. Baldwin and Shillington co-wrote an article on pension reform in Canada and noted that the Canadian government reform is incomplete. They suggested that the Canadian government has not considered how the current labour market trends affect the Canadian pension environment. They note that slower labour force growth, and the differences in age Canadians enter and exit the labour force need to be factored. An article in The Globe and Mail suggested that the expansion of the CPP is putting pressure on both workers and employers for additional contributions which can affect the Canadian economy. 

So even with the grand vision for no financial worries in retirement, the reality is that for most people, the biggest issue they have when it comes to their future, is “will I have enough?”  Advisors play an important role in ensuring that all Canadians understand and plan for their own investments to prepare for retirement, including their rights to access public programs such as CPP and Old Age Security in the most tax effective way, to make sure they get the most from the A lifetime of work. 

Claiming Office Expenses: Proprietorship vs Employed Tax Guidelines

With the April 30 deadline for individuals now a thing of the past, it’s time to focus on getting those proprietorship returns filed! The deadline to avoid late filing penalties is Monday, June 17 this year, but it’s a good idea to get those returns in sooner.  Here’s why:

Tax Tip for Proprietorships:   Remember, for the self-employed, while the deadline to file is June 17 at midnight; the deadline to pay amounts owing to the CRA was midnight April 30. This means you’ll incur unnecessary interest charges with each day you file late.

Proprietors should be especially careful to file an audit-proof tax return.  They, unlike most employees who obtain T4 slips that are easily checked by the CRA, bear a larger “burden of proof” under our self assessment system of taxation.  All income and deductions must be properly accounted for (understatement of income or overstatement of deductions can result in gross negligence and potentially tax evasion penalties). 

Of particular concern are “mixed use” expenses.  That simply means that any personal portion of expenditures are not deductible.  A good example includes claiming home office expenses, which are particularly tricky because the deductions that qualify for the claim differ for the self-employed, compared to employees or employed commissioned salespeople. 

If you are claiming them, pay particular attention to the following guidelines, which were excerpted from the 2019 edition of Essential Tax Facts, by Evelyn Jacks. This new book, which will help you assemble the correct information for filing your 2019 tax return next tax season will be shipping on May 24 and so be sure to get your pre-order in now.

Home Office:  What can employees claim? What can the self-employed claim? Here are the differences, and what claims are allowable:

  • Employees who do not earn commission can claim: utilities, maintenance and repairs, including light bulbs and cleaning supplies, and rent.
  • Commissioned sales employees can claim: utilities, maintenance and repairs (including light bulbs and cleaning supplies), rent, insurance, and property taxes.
  • Self-employed people can claim: utilities, maintenance and repairs (including light bulbs and cleaning supplies), rent, insurance, property taxes, interest, and Capital Cost Allowance (although this is not a good idea if the home is your principal residence, as you have learned. CCA claims will compromise the principal residence exemption.)

It’s also important to note that eligible claims for home office expenses are limited to income – which is one similarity for both the employed and self-employed. An employee may not claim home office expenses that exceed the income from their employer or income from commissions earned. A self-employed person may not create or increase a business loss with a claim of home office expenses. But the good news is that non-deductible home office expenses may be carried forward (indefinitely) to reduce income in future years.

To qualify to make home workspace expense claims, the space must be:

  • The place where the individual principally (more than 50% of the time) performs the office or employment duties, or
  • Used exclusively in the period to earn income from the office or employment and, on a regular and continuous basis, for meeting customers or other persons in the ordinary course of performing the office or employment duties.

The home workspace must be separated from other living areas in the home, but does not need to be a separate room. Also, the home may either be owned by the taxpayer or rented.

To determine the amount of deductible home office expenses, total expenses for the costs of maintaining the home are pro-rated by a fraction that accounts for the square footage of the home workspace over the square footage of the entire living area of the home.

Employees are subject to further requirements:

  • A completed Form T2200 Declaration of Conditions of Employment, on which the employer certifies that the employee is required to maintain the home office or use the car for employment purposes, and pay the expenses out-of-pocket is required. This form must be signed by the employer.
  • Employees’ claims for home workspace and auto expenses are made on Form T777 Statement of Employment Expenses.  Keep receipts and an auto distance log.

Lucrative Tax Breaks for Families with Children

An often under-claimed and misunderstood tax deduction is the claim for babysitting or child care expenses. Make the claim on auxiliary tax form T778 and generally you will do so on the return of the spouse with the lowest net income. However, there are cases where the higher earner can make the claim. Here are the rules:

Eligible child care expenses. Claimed on line 214 of the tax return, eligible child care expenses include costs of care that apply in order to allow a parent or caregiver (living with and primarily responsible for the child) to do the following:

  • Earn income from employment
  • Carry on a business either alone or as an active partner
  • Attend school under the conditions identified under Educational program
  • Carry on research or similar work, for which you or the other person received a grant

Note that Employment Insurance benefits and passive investment income sources don’t count for these purposes.

Claiming child care expenses. Receipts documenting child care costs must be kept.Child care expenses must normally be claimed by the lower-income spouse. However, they may be claimed by the higher-income spouse during a period where the taxpayer was separated from the other supporting person due to a breakdown in their relationship. This must have occurred for a period of at least 90 days, as long as they were reconciled within the first 60 days after the taxation year.

If the taxpayers were not reconciled within 60 days after the taxation year, then each spouse may claim any child care expenses they paid during the year with no adjustment for child care expenses claimed by the other taxpayer.

In addition, the higher earner may make the claim if the lower earner was a full time student, incapacitated or incarcerated.  

Other tax credits and benefits for families with children. The child care expense deduction is particularly lucrative not just because it reduces taxes payable, but because it also reduces net income, the figure upon which other refundable and non-refundable tax credits are calculatedOther benefits and credits eligible families will want to ensure they receive include:

  • Canada Child Benefit (CCB) which was enhanced in July of 2018 to increase accessibility to Canadians.
  • GST/HST credit.
  • Provincial benefits and credits.
  • Child Disability Benefit.
  • Working Income Tax Benefit (now called the Canada Worker’s Benefit)
  • Children’s special allowances.

These credits and benefits don’t need to be re-applied for annually, but to ensure they’re received continuously by eligible families, taxpayers need to file their yearly tax returns even if they made no income during the year.

Child care expenses can also be used to reduce withholding taxes, along with RRSP contributions, moving expenses, deductible employment expenses, medical expenses, interest on investment loans, tuition fees, and charitable donations. This is something that most people aren’t aware of, and all it takes is filing form T1213 Request to Reduce Tax Deductions at Source, for taxpayers to see that money appearing back on their monthly paycheques!

Planning ahead, all child care expense receipts for 2018 should be in order and filed for audit purposes, while 2019 receipts for January to April are ripe for assembly as well. New parents in 2019, in particular, should seek extra help with their tax filing rights with a visit to their professional tax specialist for specific questions and advice.

Be sure to get your copy of Essential Tax Facts 2019, by Evelyn Jacks, available May 24! This new book will help you prepare for the 2019 tax season, and is integral resource to help educate and inform taxpayers. Pre-order yours today by calling 1.866.953.4769!

14 Income Sources that Attract No Tax

Canadians pay a lot of tax! In fact, tax is the single greatest lifetime expense: an average two-income earning family could pay in excess of $1 million over their lifetime. While meeting with clients to file their 2018 taxes, it’s a great strategy to discuss the tax exempt income sources. Planning to earn more of them will help with cash flow and paying less tax next season.

The most common types of exempt income include the following.

  1. TFSA (Tax-Free Savings Account) income earnings and withdrawals
  2. Inheritances
  3. Lottery winnings
  4. Capital gains on the sale of a home used as a tax exempt principal residence (although you must file Form T2091 (IND) Designation of a Property as a Principal Residence by an Individual to report the disposition)
  5. Capital gains on publicly traded shares donated to a registered charity or private foundation
  6. Income exempt by virtue of a statute including the Indian Act
  7. Canadian Service Pensions, War Veterans Allowance Act Allowances
  8. Proceeds from accident, disability, sickness or income maintenance plans where the taxpayer has made all the (non-deductible) premiums
  9. Social Assistance Payments received for providing foster care
  10. Scholarships and Bursaries for certain qualifying full-time post- secondary students or that relate to elementary or secondary programs
  11. RCMP Pension or Compensation received in respect of an injury, disability or death arising directly out of, or directly connected with, the service of a member in the RCMP
  12. MLA and Municipal Officers Expense Allowances but only until the end of 2018, when unaccountable allowances become taxable
  13. Service Pensions from Other Countries on account of disability or death arising out of war service received from a foreign country that was an ally of Canada at the time of the war service
  14. Tax-free benefits of employment, including transportation to a special worksite, certain transportation passes, uniforms supplied to the employee, education taken in order to benefit the employer, etc.

It’s also essential to ensure that income isn’t over-reported, and that you find the above tax-exempt opportunities by conducting thorough interviews with your clients. Not just once – but annually – to ensure you capture new opportunities as they arise.

This list of tax exempt income sources was excerpted from the 2018 edition of Essential Tax Facts by Evelyn Jacks. The 2019 version will be available this May! It’s a great resource to share with your clients, to make them more tax-savvy. Pre-order your copies by calling 1.866.953.4769.

Thought Leadership: Developing Brand Loyalty at Tax Time

Although many of you are in the midst of the hustle and bustle of tax season, this is actually a great time to develop brand loyalty with your clients. After all, you may be seeing many of them for the first time all year. This creates an opportunity for you to set yourself apart from your competitors and get that valuable referral business. But what does brand loyalty mean, and how do you establish it?

Defining brand loyalty. Consumers are far more likely to choose a brand that they recognize over something they are unfamiliar with, which is why many of the products and services we purchase today come from national or internationally branded chains. But this applies with smaller businesses as well. Specialty or boutique services can also establish brand loyalty if their brand clearly defines who they are in their market space, which increases their appeal with the public.  

When customers recognize and use your brand, it begins to build your brand equity in several ways. Firstly, it starts the process of creating customer loyalty and return business. Secondly, it starts to build your customer referral base. These are the people who use your service and share their positive experiences with their family and friends. With the lightning speed of social media communication, your brand equity begins to develop the moment your first customer posts something complimentary about you online.

The more recognition you receive and the more you build your brand, the more your company will be viewed as a leader in the marketplace by not only your customers, but also by your suppliers, and potential current and future stakeholders.

This dictates that when building your brand, you must consider both the short-term value and the sustainability of the brand over time. How do you do this? 

The following steps are discussed in Knowledge Bureau’s new certificate course Business Leadership, Culture and Continuity which is part of the MFA™ – Executive Business Growth Specialist program. 

  1. Identify: start by clearly identifying what you stand for. Product-based companies can usually easily identify this by the quality of what the products they offer. However, for service-based companies it can become more complex. 
  2. Explain: once you have a sense of your brand pillars, you can begin to describe and explain your brand’s value proposition. This is basically your “elevator pitch”. In one short statement, it tells your prospective customers both what you do and what values you bring to the people you serve.
  3. Share: the next step in building out your brand is to begin the sharing process. Unfortunately, this is often where most business owners “jump the gun” and begin to share their brand story prematurely. The story of why/how they started their business gets woven and tangled into a confusing array of communication through a variety of tools. This confuses the market about who you really are.
  4. Validate: this step in your brand development is focused on establishing credibility to what you claim to offer. You accomplish this by incorporating customer referrals, testimonials, and the like into your communication channels.
  5. Grow: once you have validated your brand and your positioning in the marketplace, it is time to turn it up and grow your distribution.

Why is brand loyalty an especially timely issue? Due to the sweeping tax changes in the US, Canadian companies are deemed to be at a marked disadvantage, comparatively speaking. Reforms such as reductions of corporate tax rates, caps on small business tax, and deductions for capital investments have the Canadian business community increasingly concerned that our more stringent regulatory environment and higher taxes will make us less competitive.

The Canadian Chamber of Commerce has developed its most comprehensive policy position requesting that the federal government strike a royal commission on tax reform to help with Canadian economic competitiveness issues. Including that the Canadian tax system hampers investment and the ability of business owners to attract talent. 

Any tax reform will take time and consultation. In the meantime, Canadian business owners have to find ways to stay as competitive as possible despite a series financial obstacles that take money out of consumers’ pockets:  new taxes, economic uncertainty, debt management . Creating brand loyalty is one tool in your arsenal to ensure your business will grow in the future and be able to weather any storm!

Good News for Seniors: GIS Clawbacks Reduced

Old Age Security (OAS) and Guaranteed Income Supplement (GIS) benefits payable were released on April 1 for the second quarter –  but unfortunately, seniors won’t be getting a raise. However, there is some good news about Canada’s public pension system, especially for low-income seniors who have employment or self-employment earnings, and for tens of thousands of seniors who haven’t been getting their CPP benefits.

First, for the second quarter of 2019 (April to June), the benefit rates remain as follows:

Family Situation Maximum Income (excluding OAS) Maximum Amount Reduction Rate*
Single, widowed, or divorced senior $18,240 $898.32 $1/$24
Spouse receives full OAS $24,096* $540.77 $1/$48
Spouse does not receive OAS $43,728* $898.32 $1/$96 over $4,096
Spouse receives the Allowance $43,728* $540.77 $1/$48

*The benefit is reduced by one dollar for each multiple of income level shown (e.g. $1 for each $24 of income for a single senior). Note that the first $3,500 of employment income does not count.
** This refers to combined income of both spouses

How are OAS and GIS rates determined? Rates are indexed quarterly based on the Consumer Price Index (CPI) for the most recent three months ending in the last increase compared to the CPI for the previous three months.  The CPI for November 2018 to January 2019 was lower than the CPI for August to October 2018 so the indexation factor, if implemented, would actually reduce the OAS payment amounts. However, when the indexation factor is negative, the payment rates do not change.

The basics on GIS eligibility. The allowance is available to low-income seniors aged 60 to 64 who are married to a pensioner or are the surviving spouse of a senior.

Changes to GIS clawbacks. There is some good news for GIS recipients starting in July 2020.  Currently, GIS recipients can earn up to $3500 of employment income without affecting their GIS pension. However, if they earn more, the GIS is reduced by 50% of the excess earnings.   That’s a steep clawback.

Beginning with the July 2020 to June 2021 benefit year, which are based on income earned in 2019, GIS recipients can earn up to $5,000 from employment or self-employment before their GIS is reduced. In addition, 50% of the next $10,000 of employment or self-employment income will also be exempt.

These changes would allow working seniors to earn up to $10,000 more in 2019 while still receiving benefits under the Guaranteed Income Supplement.

Automatic CPP enrolment. In the March 19, 2019 federal budget, it was proposed that eligible seniors age 70 and older would be automatically enrolled in the CPP program. It’s an important change when so many seniors continue to miss accessing public pension programs that can help significantly with financial security throughout retirement.

It’s an issue made evident by statistics relating to the GIS, which is missed by more than one in ten seniors, per a Statistics Canada report we covered in January.

Once implemented in 2020, the automatic enrollment process promises to bring CPP to 40,000 eligible seniors currently missing it, over a twenty-year period.

By Knowledge Bureau writers Walter Harder & Beth Graddon

Post-Budget Hot Topics: Discuss the Home Buyers’ Plan Now

The March 19, 2019 federal budget was released last week, and along with it came a few hot topics advisors should consider discussing with clients now. After all, proposed changes to the Home Buyers’ Plan, stock options, and mutual funds will affect Canadians and their wealth management strategies in the coming years. In this edition of KBR, we’ll take a deeper dive on the RRSP’s Home Buyers’ Plan.

One of the most discussed items to come out of the 2019 federal budget was the proposed changes to the Home Buyers’ Plan. For the RRSP Home Buyers’ Incentive, individuals with savings in their RRSPs will be able to tap into more of their savings on a tax -free basis under the Home Buyers’ Plan. An increase in withdrawal from $25,000 to $35,000 will be allowed; couples can thus withdraw up to $70,000 under the HBP. The increased withdrawal limit will also apply to the acquisition of a new home to be more accessible to a disabled person. However, the money will need to be repaid in 15 years or added to income, as per existing rules. This change will take effect after March 19, 2019.

Along with an increase to the limit on RRSP withdrawals within the Home Buyers’ Plan, the federal budget introduced new rules to include couples who experience a relationship breakdown. Effective after 2019, couples who separate or divorce may participate in the Home Buyers’ Plan as individuals even if they don’t otherwise qualify as a first-time buyer.

To qualify, an individual must be living apart from their former spouse or common-law partner at the time of the withdrawal and the separation must have occurred in the current or four preceding years. In addition, the taxpayer may not make a withdrawal if they move into a home owned and occupied by a new spouse or common-law partner.  Where the purpose of the HBP withdrawal is not to buy out the share of the residence owned by the former spouse or common-law partner, the former principal residence must be disposed of no later than two years after the HBP withdrawal. Taxpayers who have an existing HBP balance may not make a new HBP plan withdrawal until the former plan withdrawal is repaid.

In an attempt to make buying a first home a little more attainable, the March 2019 federal budget also announced that CMHC will be offering a shared equity mortgage to qualifying home buyers. First-time home buyers whose household income is $120,000 or less may qualify for a CMHC shared equity mortgage of 5% of the cost of an existing home or 10% of the cost of a new home. To qualify, the CMHC insured mortgage plus the CMHC shared equity mortgage must be less than four times their annual income. 

There will be no payments or interest accruing on the shared equity mortgage, but it must be repaid when the home is sold. It remains unclear whether the amount to be repaid on sale is the original amount provided by CMHC or a percentage of the sales price equivalent to the percentage of the equity invested. The program details are to be released later, but it is expected to be operational by September 2019. 

Information compiled from our Special Budget Report by Christine Steendam, Assistant Publisher at Knowledge Bureau.

Charitable Sector Reform: CRA Lifts Suspension on Audits and Restriction on Political Activities

The nature of the charitable sector is changing in Canada. On March 7, 2019, the Minister of National Revenue issued four key recommendations for the administration of new rules relating to the political activities of charities. Some in the sector are rejoicing, but others are wondering about the long term impact of the changes.

The big news: policy development and discussions relevant to their charitable activities can now can be pursued without limitation, as long as the charitable organization operates exclusively for philanthropic purposes.

New legislation, passed on December 13, 2018, will apply retroactively to September 14, 2018 and now allows CRA to lift a suspension of audits in progress in the interim pending guidance on the implementation of these new rules. Those charities will hear from the government shortly on the status of their files. Here’s a synopsis of the recommendations for change in the charitable sector:

Charitable Purpose. CRA’s first recommendation allows charities to engage in the development of public policy and development without limitation, provided these activities are carried out exclusively for a stated charitable purpose. The CRA has developed and published a guidance document on the administration of this policy, which is open for feedback until April 23, 2019. 

Outreach Funding. Through its second recommendation, the government will provide up to $5.3 million in new funding in the period 2018-2019 to 2023-2024 to enhance charitable sector outreach, as well as education and internal education for employees. It will conduct in-person visits with registered charities to provide support that will help them meet obligations to maintain their charitable status.

Charitable Activities. Recommendation 3 discusses changes to the rules that govern the political activities of charities. With Royal Assent on December 13, 2018, the new rules explicitly allows charities to fully engage (without limitation) in political activities. However, they must further a stated charitable purpose and cannot support or oppose any political party or candidate for public office, directly or indirectly.

Jurisprudence. The government  has also decided to discontinue its appeal of the decision in Canada Without Poverty v. AG Canada case which which restricted registered charities from participating in political activities that exceed 10% of its resources. This Ontario case was overturned as the legislative provisions at issue in the litigation are no longer applicable following the above-mentioned changes. This decision is controversial to some; the reasons for which are well outlined in an article from Mark Blumberg, July 2018.

To assist with the new landscape, Recommendation 4 establishes a permanent Advisory Committee on the Charitable Sector (ACCS) to provide recommendations to the Minister of National Revenue “on important and emerging issues facing charities and qualified donees on an ongoing basis.”

The Government is also providing $3.2 million in new funding to the CRA over the 2018–2019 to 2023–2024 period to support the ACCS in strengthening the relationship between the government and the charitable sector.  

Knowledge Bureau Report is interested on your take on the matter. At its core, the issue encircles the question: which political views should be subsidized through the tax system and which should not?

You may wish to weigh in on the issue, as readers did when we asked our readers their views about changes to the charitable donations tax credit (see results of our previous poll.)   At that time, financial professionals largely indicated that they were in opposition to new donation tax credits for a new category of donees that are non-profit journalism organizations that produce a wide variety of news and information.  These organizations will be able to now issue receipts in the same manner as other registered charities.  

Meanwhile, here is a timeline issued by the government on how this charitable sector reform unfolded:

  • Fall 2016: The CRA held online and in-person consultations
  • September 2016: The Consultation Panel was established
  • May 2017: The Minister welcomed the Panel Report on the public consultations on charities and political activities and asked the CRA to suspend all action related to the remaining audits and objections under the Political Activities Audit Program
  • August 2018: Statement by the Minister of Finance and Minister of National Revenue on removing restrictions on political activities of charities
  • October 29, 2018: New legislation was tabled
  • November 21, 2018: The government announced the creation of a new permanent Advisory Committee on the Charitable Sector (ACCS) as part of Fall Economic Statement 2018
  • December 13, 2018: New legislation received Royal Assent

Knowledge Bureau Poll: High Tax Refunds Spur Controversy

Is the tax refund a good thing? It’s a question that spurred a great debate in February’s Knowledge Bureau poll when we asked tax and financial professionals whether or not the withholding taxes that lead to a tax refund should be reduced to help taxpayers save or pay down debt. Did the no side or the yes side win? You’ll be surprised by the results.

While the votes were split almost down the middle (58% no, 42% yes, from a total of 266 votes), the comments revealed that most agree about one fundamental concept: having taxpayers receive such large refunds means that the government is getting significant interest-free loans from taxpayers, and that’s not ideal.

The debate itself came down to a behavioral finance factor: taxpayers look forward to these returns and factor them into their financial planning each year, whether it’s the most strategic approach or not. So, reducing CRA tax withholdings means that many advisors have to re-align their clients’ way of thinking and their approach to money management – and they were divided on whether or not that could be effective.

Read on for more insight from February’s poll, starting with some comments from respondents who voted “no”:

Cindy outlined why having the extra cash flow monthly might be ineffective: “I wish I could say yes, but a lot of Canadians are not responsible enough to use the extra monthly cash in a beneficial way.”

Clare gave a succinct summary of why this is such a highly-debated issue: “Most prefer to have the refund, it has turned into a short-term savings account. Maybe we should encourage the CRA to pay interest on the refund. It would push the CRA to reduce the amount of taxes taken as they won’t want to pay interest, but recognize the amount as a true short-term savings account for the taxpayer.”

Joanne agreed, explaining that she’s tried to re-align her clients’ perceptions about the tax refund: “In spite of advice to the contrary, many clients still want the refund at the end of the year. Their idea of a reward at tax time or forced savings. I do, however, explain their options and the reasons.”

Mitzi-Lynne used an important example to highlight why she voted no:  “I thought about this and I don’t think it would help, except in very rare cases. My clients all want that refund at tax filing time. If the deductions were used to reduce taxes paycheque by paycheque, the bills would still pile up, the bit extra on the paycheque would be spent on trivialities, nothing would get saved and at the end of the year there would be zero refund. Typically, my clients claim the Northern Resident Deduction. They could get this benefit paycheque by paycheque by putting it on the TD1, but they kick up dust at tax time because don’t understand that they already had that benefit, (and wasted it!) and you only get it once.  I think that reducing the tax payments over the year would not benefit many people. It may be better that we try to do a bit towards saving them from themselves.”

Daniel stated that there could be repercussions if the government stops withholding too much tax: “I think the tax refund scenario is a win-win for everyone. The government gets the free use of our money for part of a year, and we get a forced savings with a lump-sum payout at the end of the year. If not withheld from paycheques, many taxpayers would spend it all as soon as they receive it anyway. And if the government didn’t get the free use of our money throughout the year, they would instead need to raise the tax rates. Would we like that any better?”

Frank said: “While a lesser refund would totally make sense, since it is the taxpayer’s money the government is working with, many people would not really benefit from it. Many taxpayers wait for that cash tax refund to make a purchase or go on vacation. All of these taxpayers who expect that refund would not save a dime during the year. Without this little bright light of the refund, they may not ever make their purchase, take their vacation, or worse, pay down debt.”

Tim explained how it may depend on the circumstances:  “I would like to know what deductions and/or credits are being claimed to generate the $1,700 refund. Is this a one-time RRSP purchase in February? If so, the CRA had use of the refund for only about two months. Even if it was monthly contributions out of your bank account and not through work, average it out over the year and, really, how much interest are you losing? Is it from a year-end charitable donation? Again, not really much interest lost. If it’s a disability credit claim for a dependent or spouse, then, yes, the TD1 should be filled out and given to your employer to reduce tax withholdings.”

Alice pointed out that reducing withholdings risks that taxpayers will owe: “I would hesitate to recommend lowering withholding taxes, as it may create owing tax at the end of the year and this is very hard for taxpayers to deal with. I always find there are employees who ask to have more tax taken off each paycheque.”

Jo agreed: “I would hesitate to recommend lowering withholding, as I have worked with too many clients who depend on the ‘Rev Can savings plan’ and for whom actually owing would be a disaster. Indeed, when doing payroll, I always find there are employees who ask to have more tax taken off each paycheque. It is easy to look at this $1,700-plus as a ‘wasted’ opportunity but — especially for those taxpayers who don’t have that much discretionary income — this is the best way for a lot of people to accumulate some savings.”

Gaetan stated: “In my 35+ years as a tax accountant, the vast majority of my clients (90%+) want to see a refund from their tax return filing. The reason for this is that they see the refund as a tax-free “bonus” part of their income. They do not see it as paying too much in income taxes. Many of my clients actually rely on a tax refund to finance their vacations, home renovations, etc. If their tax deductions are reduced at source (from their paycheques), their standard of spending will simply increase accordingly. They see their refund as a type of ‘forced’ savings tool. Even after I explain to my clients that this means the government had their hard-earned money for more than 12 months, interest-free. My clients simply want a refund every year!”

Here are some comments from those who voted “yes” – which weren’t that different from many of the “no’s,” demonstrating why this is such a complex issue to debate.

Leanor indicated how addressing this issue with business clients opens up a whole different conversation: “You are all looking at the individual taxpayer, but what about the business taxpayer, who pays monthly corporate tax on the basis of the profit of the previous year end—business becomes slow so very little profit, but you have paid monthly to the CRA. Try getting that back in a timely period after you have filed your year-end—you will no doubt expect an audit as they hate to give up money paid in two years ago. Expect an audit which is very time consuming and a great expense to the business owner. CRA would give you penalties back to each month’s corporate tax bill if it wasn’t correct by their auditors.”

Ron explained that from a professional standpoint it makes sense, but he is concerned about the impact it would have on taxpayers: “Yes I think withholdings should be reduced, but there are just so many folks out there that use their tax refund as their savings account! And they will be happy with a big refund rather than the smaller amounts they would get each month, which would then just get spent! Many treat that refund much more wisely than they would with an extra few dollars on their paycheques!”

Prith said “yes,” but added that the CRA needs to introduce a more comprehensive assessment: “We need comprehensive assessment, it would make more sense. Then, the people who know they have high medical could use those to bring down their withholding.”

Doris agreed: “There are things that bring down your tax over and above the items listed on the TD1. If that was more comprehensive, it would make more sense. Then the people who consistently tithe, or know they have high medical, could use those to bring down their withholding.”

Pat said it would help seniors, in particular: “I suggest to seniors who get a refund that they should reduce it. Better to have the money monthly. I usually tell them it is better they get to spend their money than their heirs. Also, in BC, after the age of 55 we can defer our property taxes. It really helps!”

Heather pointed out how reducing withholdings demands professional advice: “Advisors, both tax and planners, should be working with their clients to update the TD1 each year. Another value-add that gets missed too often.”

Martin outlined the challenges, and offered a solution: “Yes, withholding should be reduced a little. It’s a free loan to the government. Having said that, however, many taxpayers would not reduce debt or save it, but consider it just more cash in their pocket to be spent. They just wouldn’t have to wait until the following April to receive it. A person can already ‘reduce tax deductions at source,’ if they make arrangements to make contributions to an RRSP and have their employer fill out the form. That way, it is a forced savings.”

Thank you to everyone who weighed in on February’s highly-debated poll question! This month, we’re changing gears and asking: In your opinion, is it as difficult to envision life after retirement as it is to save for it?” Vote now!