Canadian Income Taxation - Ch07

CHAPTER 7:
Income from Property
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1
I. Income from Property
I. Income from Property Defined

II. General Rules for Determining Property
Income
III. The Unique Features of Property Income
IV. Impact on Investment Decisions
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Return on invested capital where:

little or no time, labour or attention has been expended.
Dividends - shares
Interest loans, deposits etc
Rental income real estate
Royalties patents etc.

Property income is the annual or regular return received

for allowing another party to use ones property.
ITA 16(1) - Does not include capital gain or loss.
Capital Gain
Or Loss

Income
ITA 9(1)
property income = profit there from.
Reflects the net concept:
Property revenues
less
Related expenses

Income
Expenses incurred to earn property income are deductible
if:
a) Incurred to earn taxable property income;

b) Not capital in nature;
c) Not a reserve;
d) Not a personal or living expense; and,
e) Reasonable.

Property Income and the Taxation Year
Property income is determined annually
Individuals:
Coincide with Calendar year.
Corporations:
Coincide with fiscal period.

The Deduction of Interest Expense
ITA 20(1)(c) - Deductible if loan was to purchase

investments to earn property income.
Loan documentation:
Must establish purpose of loan:
Maintain separate accounts.

Principles for Maximizing
After-tax Cash Flows
1. Use excess cash to purchase personal assets.
2. Use borrowed funds to purchase investment assets

maintain clear records.
3. Use excess cash to pay down personal debt first.

Interest paid on personal loans is not deductible.

Principles for Maximizing
After-tax Cash Flows
Consider an individual who borrows $10,000 at 10% to
purchase either a Cottage or an investment. Individual has a tax
rate of 45%.
Cottage personal use Investments

Loan $10,000 Loan $10,000
Interest paid 1,000 Interest paid 1,000
Tax saving 0 Tax saving (450)
Cost of loan Cost of loan
after-tax 1,000 after-tax 550

III. The Unique Features of Property Income
Interest income the compensation received for the

use of borrowed funds.
ITA 12(1)(c) - Corporations on an accrual basi

Include as income on a daily basis,
even though not received or receivable until some future time.

Individuals and interest income
ITA 12(1)(c) - Individuals have three options:
1. The receivable method

2. The cash method
3. The annual accrual method

May choose any of three methods.
Method chosen is consistently for that investment.
Receivable method:
included in income when the amount is legally due and
payable.

Cash method:
Included in income in the year received.
Annual Accrual Method:

Supplementary rule even though may choose either the cash
or the receivable method
Requires that interest income be recognized for every 12-
month period from the date the investment was made ITA
12(11),(4).
Means interest can only be deferred for limited period.

Required
Annual Accrual Method method so
cannot defer
for long
Loans $100,000 on February 1, 20X1. Loan must be repaid in two periods
years. Interest is charged at 12%, compounded annually and is
payable at the end of two years.
Cash Method Annual Accrual Method

Year Income Year Income
20X1 0 20X1 0
20X2 0 20X2 $12,000
20X3 $25,440 20X3 $13,440
Total $25,440 Total $25,440
Yr 1 100,000 x 12% = $12,000

Yr 2 112,000 x 12% = 13,440
$25,440

Foreign Interest
Interest earned recognized in Canadian dollars.
Gross amount is included:

Amount received plus foreign taxes withheld.
If foreign tax is withheld may receive a foreign tax credit

ITA 126(1),(2).
Reduces Canadian taxes, if applicable.

Deductions from Interest Income
Interest paid on loans to acquire investments ITA 20(1)(c).

Investment counselling fees - ITA 20(1)(bb).
Costs incurred to obtain a loan - 1/5 per year ITA 20(1)(e),(e.1).
Investment management fees.
Accounting fees.
Fees paid to a financial institution to hold
securities.
Reserves for uncollectibles where interest income has been
accrued - ITA 20(1)(l).

Deductions from Interest Income
A loss from property can offset other sources of income.
Expenses Property
>
Income

Dividend Income
Dividends the returns provided on the investment in

shares of a corporation
Dividend income can be received by both individuals and

corporations.

Dividend Income
Corporate Ownership:
Individual Individual
Dividend
Dividend Corporation
Dividend
Corporation Corporation

Dividends Received by Corporations
ITA 12(1)(j), (k) - Included in net income for tax purposes

when received.
ITA 112(1) - Dividends received from a taxable
Canadian corporation are deducted when arriving at
taxable income.
In and out calculation.
Result:
Inter-corporate dividends are not taxed.
Removes possibility of multiple taxation.

Dividends Received by Corporations
ITA 113(1) - Foreign Corporation Dividends:

only excluded from taxable income if the foreign corporation
qualifies as a foreign affiliate.
A foreign corporation qualifies:
if Canadian corporation owns not less than 10% of foreign
corporation.

Dividends Received by Individuals
Dividends from taxable Canadian corporate shares are

included when received.
ITA 12(1)(j) - Grossed Up:
Received from Private Corporations:
118% (2015) - if eligible for special low-tax rates - Non-Eligible
dividends. Gross up decreases gradually from 2016 to 2019.
138% - if not eligible for special low-tax rates Eligible dividends.
Received from Public Corporations:
138% - Eligible Dividends
A dividend tax credit (DTC) is available Chapter 10.

Eligible Dividends Received by Individuals
Corporation
Income $1000
Tax @ 27.5% (275)
Net earnings $ 725
Individual Shareholder:
Dividend from Corporation $ 725
Taxable dividend ($725 x 1.38) $1,000
Tax @ 45% 450
less DTC (275)
Net personal tax $175
Total tax paid on Corporate profits
Paid by corporation $ 275
Paid by individual 175 $450

Corporation
Changes
Income $1,000
from 2016-
Tax @ 15% (150)
2019
Net earnings $ 850
Individual Shareholder:
Dividend from Corporation $ 850
Taxable dividend ($850 x 1.18) $1,000
Tax @ 45% 450
less DTC (150)
Net personal tax $300
Total tax paid on Corporate profits
Paid by corporation $ 150
Paid by individual 300 $450

ITA 12(1)(k) - Dividends from foreign corporations:

Not subject to the gross-up and
NO Dividend tax credit treatment.
Actual amount of dividends (before withholding taxes) is
included in income in the year received.

Stock Dividends
Stock dividends corporation issues additional shares in

lieu of a cash dividend
Deemed to be a taxable dividend;

Individuals dividend is subject to gross-up and DTC ITA 248(1).

Rental Income
Compensation received for allowing another party to use

ones property.
Included on accrual basis:

When earned
Regardless of when received.
Early payments of rent can delay recognition until

earned
Rental Income = Rent Expenses

Deductions from Rental Income
Interest expenses Landscaping costs around a

Costs incurred to obtain loan building
financing CCA
Insurance and property taxes Salaries and wages
Repairs Property management fees
Maintenance costs Accounting costs
Utility costs Costs incurred to collect
Advertising rents

Special Rules for Capital Cost Allowance
Two special rules - apply only to rental property:
1. Reg. 1100(11) - CCA claimed on rental properties cannot:

Create a rental loss, or
Increase a rental loss,
from all rental properties combined!
2. Reg. 1101 (1ac) - Separate classes for each rental building
costing $50,000 or more.
No pooling of rental property =/> $50,000.
Means when sold will always trigger recapture or terminal loss
- Even when new building is acquired in same year.

Royalties
Normally treated as property income

Usually require little if any effort to achieve revenue
Can be considered Business income if considerable effort

is made to earn the income
I.e. musicians, authors etc.

A. Cash Flow and Return on Investment
Interest-bearing securities:
- Timing of tax payment may not coincide with cash
received.
Investment in corporate shares:
- Dividends, and/or
- Growth in value (taxation discussed in Chapter 8)
Real Estate Investments:
- CCA deductions, and
- Recapture
The ultimate after-tax yields vary considerably.
Must examine relative risk and expected returns of
each alternative investment.

B. Business Organization Structure:
Separating appreciating assets

- Provides protection from business failure,
- Separate fortuitous gains from profits,
- May accelerate recapture due to separate class
requirements for rental property.

C. Corporate Financing
Debt versus Equity financing:

- Understanding varying tax treatments of property
income on investors rate of return.
Corporate financing Chapter 21

D. Splitting Property Income among Family members

Attribution Rules
Tax rates vary among family members

Attempts to lower overall family taxes paid by investing
family savings with lower income individual
Anti-Avoidance Rules property income included in income
of the taxpayer who created the wealth
Not limited to property income.

Canadian Income Taxation - Ch07

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CHAPTER 7:

Income from Property

Electronic Presentations in Microsoft PowerPoint

Copyright 2016 McGraw-Hill Ryerson, Limited. All rights reserved.

I. Income from Property Defined

Copyright 2016 McGraw-Hill Ryerson, Limited. All rights reserved. 2

Return on invested capital where:

Copyright 2016 McGraw-Hill Ryerson, Limited. All rights reserved. 3

Property income is the annual or regular return received

ITA 16(1) - Does not include capital gain or loss.

Copyright 2016 McGraw-Hill Ryerson, Limited. All rights reserved. 4

Reflects the net concept:

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a) Incurred to earn taxable property income;

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Property income is determined annually

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ITA 20(1)(c) - Deductible if loan was to purchase

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2. Use borrowed funds to purchase investment assets

3. Use excess cash to pay down personal debt first.

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Cottage personal use Investments

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Interest income the compensation received for the

ITA 12(1)(c) - Corporations on an accrual basi

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ITA 12(1)(c) - Individuals have three options:

1. The receivable method

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May choose any of three methods.

Method chosen is consistently for that investment.

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Annual Accrual Method:

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Cash Method Annual Accrual Method

Yr 1 100,000 x 12% = $12,000

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Interest earned recognized in Canadian dollars.

Gross amount is included:

If foreign tax is withheld may receive a foreign tax credit

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Interest paid on loans to acquire investments ITA 20(1)(c).

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A loss from property can offset other sources of income.

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Dividends the returns provided on the investment in

Dividend income can be received by both individuals and

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ITA 12(1)(j), (k) - Included in net income for tax purposes

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ITA 113(1) - Foreign Corporation Dividends:

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Dividends from taxable Canadian corporate shares are

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ITA 12(1)(k) - Dividends from foreign corporations:

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Stock dividends corporation issues additional shares in

Deemed to be a taxable dividend;

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