Registered Education Savings Plan (RESP): Distribution of Funds

Amounts paid out of an RESP may be taxable, non-taxable, or may trigger a repayment of Government support. The taxation status of a receipt depends on whether it is considered an Educational Assistance Payment, a Refund of Contributions, or an Accumulated Income Payment.

Educational Assistance Payment (EAP) – An EAP is a taxable amount paid to a beneficiary (a student) from an RESP to help finance the cost of post-secondary education. An EAP consists of the Canada Education Savings Grant, the Canada Learning Bond, amounts paid under a provincial education savings program, and the earnings on the money saved in the RESP. The student includes the EAPs as income on their income tax return for the year the student receives them.

Refund of Contributions – The promoter can return contributions tax-free to the subscriber or beneficiary when the contract ends, or, at any time before. These payments are not considered income to the recipient. That said, a refund of contributions may, in some cases, trigger a repayment of Government support.

Accumulated Income Payments (AIP) – An AIP is an amount paid to the subscriber that relates to the income earned in an RESP. An AIP does not generally include: EAPs; payments to a designated educational institution in Canada; the refund of contributions to the subscriber or to the beneficiary; transfers to another RESP; or repayments under the Canada Education Savings Act or under a designated provincial program. An AIP is included in the income of the subscriber and is generally subject to an additional 20% tax rate, except where the amount is eligible for a rollover to another registered plan.

Action Item: Consider the financial consequences, tax or otherwise, on withdrawing funds from an RESP.

To read the rest of issue 116, download your copy here!

Losing the Small Business Deduction (SBD): Intercompany Payments

The 2016 Federal Budget proposed a number of measures to prevent the ability to multiply access to the $500,000 SBD limit, addressing several strategies which the Government perceived as inappropriate. Broad restrictions in eligibility for the SBD on payments between private corporations in general have been introduced. The restrictions as proposed are so broad that they will affect many corporations and structures where multiplication of the SBD was not a goal or even a consideration.
The measures will apply to taxation years that begin on or after March 22, 2016. For example, a corporation with a December 31 fiscal year-end will first be subject to these restrictions in the year ending December 31, 2017. A corporation with a March 31 fiscal year-end will first be affected in the year ending March 31, 2017.

In general, these new Specified Corporate Income (SCI) rules will restrict access to the SBD on any active business income (ABI) earned from providing services or property to another private corporation (PayerCo) where there is common ownership. Such income will not be eligible for the SBD.

Consider the situation where ServiceCo provides services to PayerCo, and PayerCo pays a fee back to ServiceCo.

Payments will be restricted by the SCI rules where an interest in PayerCo is held by any of: ServiceCo (the corporation providing the service and receiving the fees); any shareholder of ServiceCo; or, any person who does not deal at arm’s length with any shareholder of ServiceCo.

There is no de minimis ownership interest threshold – based on the draft legislative proposals of July 29, 2016, even one share of thousands will cause these restrictions to apply. In addition, even indirect interest can trigger the SCI rules. For example, if you own 10% of ServiceCo, and your brother-inlaw owns one share of thousands issued by PayerCo, these rules could apply.

An exception: if all or substantially all of ServiceCo’s active business income (which CRA generally considers to be 90%) is earned from providing services to arm’s length persons other than PayerCo, ServiceCo will not be subject to the SCI rules. The Budget also proposed that PayerCo may be permitted to assign a portion of its own unused SBD limit to ServiceCo to make the payments SCI (a special form must be filed to make the assignment).

Examples of Corporations Potentially Affected Consider a corporation, OpCo, held by four unrelated shareholders which pays management fees (or some other type of active income) to four HoldCos each owned by one of the four shareholders (whether in whole or in part).

Under the proposals, the management fees earned by the four HoldCos would not generally be eligible for the SBD, unless OpCo allocated a portion of its own $500,000 limit amongst the HoldCos. In other words, OpCo and the four HoldCos must now share access to a single business limit, assuming the HoldCos do not have ABI from other sources. Historically, each of the five corporations (OpCo and the four HoldCos) may each have had full access to the $500,000 SBD depending on their ownership and business structure.

As a second example, consider Dr. A, whose professional corporation (PC) carries on a dental practice. Dr. A’s spouse owns a second corporation (HyCo), which carries on the hygiene practice at the PC’s dental clinic. PC and HyCo are not associated, either by share structure or by de facto control. Currently PC and HyCo each have full access to the SBD. Under the proposals, if HyCo provides its services to the PC, HyCo’s income would be ineligible for the SBD, unless one of the exceptions noted above applies.

The proposals are quite broad and there are many existing corporate structures which are, or could be, exposed to these provisions. While the proposals may change during the process of becoming law, it is clear that many existing structures will be affected.

Action Item: Review your current corporate structures to determine if the small business rates will remain applicable, and whether any change in historical planning is appropriate

To read the rest of issue 115, download your copy here!

Tips And Gratuities: Employer’s Responsibilities to Withhold CPP & EI

Gratuities or tips received by employees are income earned from employment. However, it must be determined whether these tips are pensionable and/or insurable, that is, whether the employer should be withholding CPP and/or EI. This depends on whether the tips are considered to have been paid by the employer. Administratively, CRA looks at whether the tips are controlled by the employer or are considered to have been paid by the customer (a direct tip).

A December 16, 2015 Tax Court of Canada case examines whether tips paid to a restaurant’s workers were subject to CPP and EI. The restaurant’s annual revenues were approximately $6.5 million and the tips totalled $1 million. The workers divided the tips under a formula which varied over time, with all workers, including the “front-of-the-house” employees (servers and the related support staff), and “back-of-the-house” employees (kitchen staff, managers, and the catering sales coordinator) participating. The employer had withheld and remitted CPP and EI on tips paid to the “back-of-the-house” employees, so only “front-of-thehouse” employees were under Appeal.

The Employer testified that, although they deposited and paid out the tips, they considered these funds to be held in trust for the employees (likening it to GST/HST held for the Crown). The “back-of-the-house” staff were entitled to a portion of the tips, computed as a percentage of revenues, under their employment contracts. The “front-of-thehouse” employees’ contracts were silent on the matter of tips, and they shared actual tips from patrons, less the portion paid to the “back-of-the-house” staff. Their tips were paid out (in cash for some time, eventually transitioning to cheques) separate from their wages and outside the payroll system.

Taxpayer loses

The Court found that CPP and EI applied to tips paid by the employer. The Court found that “mere distribution” of the gratuities by the employer, with neither control nor ownership, is sufficient to constitute payment by the employer. The Court also noted that CRA’s published interpretations differentiate between controlled and direct tips, but that this may not be the correct test – the only determinant is whether the employer paid the tips to the employees. As the employer had paid the tips to the employees, CRA was correct to assess CPP and EI.

Action Item: Consider whether your business is properly withholding and remitting CPP and EI on tips and gratuities earned by your workers.

To read the rest of issue 114, download your copy here!