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  • Charles Rotenberg

The Times They Are A' Changin' - Part 2


In my November, 2016 Newsletter I set out some changes in the tax system that needed to be acted upon before the end of the calendar year. But there are some other changes that also affect us going forward.

Principal Residence Rules

As most of you know, there is no taxable capital gain when a principal residence is sold. Although the principal residence exemption is not being repealed, there are some significant changes effective January, 2017.

Designation

In the past, it was not necessary to actually file anything designating a house as a principal residence when it was sold. The CRA accepted that the home was a principal residence. Often a taxpayer who may have owned more than one residence would use this to, sometimes retroactively, determine which should be treated as the principal residence based upon the gains, or accrued gains, inherent in each. As of January 2017 when a taxpayer sells a home which qualifies as his or her principal residence, in order to exempt the gain from tax, the taxpayer must designate the home as such in his or her tax return for the year of the sale by filing the appropriate form. This is not a real hardship, except that many taxpayers who prepare their own returns may not be aware of the change and may neglect to file the designation form. If the designation is not filed, the principal residence exemption is not available.

Where the disposition is not reported in the taxpayer's tax return for the year in which the disposition occurs, the CRA will gain the ability to assess taxpayers, beyond the normal assessment limitation period for the tax year, in which the disposition occurred. The normal reassessment period is 3 years from the date of the Notice of Assessment. So, if you file a return for 2017 on April 30th, 2018 and receive a Notice of Assessment on, say, June 2nd, 2018, the CRA can reassess your 2017 return until June 2nd, 2021. If you fail to file the principal residence designation, there appears to be no limit to their assessment period.

Principal Residence Owned in a Trust

For a variety of tax and financial reasons, many families hold their principal residence in a family trust. For example, it may be done to protect a child from their own inability to handle finances. Often in a second marriage, a principal residence is held in a trust to ensure that, on the first death, the survivor has the ability to continue to live in the home, and on the second death, the proceeds will be split between the two families.

As of January 2017 there are new restrictions as to what forms of trusts will continue to qualify for the principal residence exemption. If the trust does not qualify, any gains after December 31st, 2016 will be taxable. Accordingly, if there is any question, a valuation of the home is advisable.

A trust set up under a Will to hold a home in trust for adult children will no longer qualify for the exemption.

It is difficult to see the "mischief" being cured by this change.

I would be pleased to work with you to determine if your principal residence will continue to qualify for the exemption and to take any necessary steps to ensure that it does.

Principal Residence Owned by a Non-Resident

Due to the manner in which the principal residence exemption is calculated, it was possible for a non-resident of Canada to get the benefit of the exemption for at least one taxation year, even if they were never resident in Canada.

After October 3rd, 2016 this loophole will no longer be available for non-residents.

Don't Forget the Interest Payments

Many years ago, high tax individuals used to lend money to spouses and children in order to generate investment income in the hands of lower rate family members. This included loans made directly to individuals and loans to family trusts. The Courts have said, in many rulings, that a loan is not a transfer. The income attribution rules were amended to include attribution on these loaned monies. If the loan proceeds were used to buy property, say shares of a family company, the attribution rules would apply to have all dividends paid on the shares, and all capital gains realized on disposition of the shares taxed in the hands of the lender. But there is an important exception for loans made that charge interest at the prescribed rate for income tax purposes. The prescribed rate has been as high as 13% or 14%, but in recent years is only 1%.

If a high rate taxpayer lends funds to a lower rate taxpayer, or to a family trust,

AND interest is charged at the prescribed rate and actually paid, the income and any capital gains generated will be taxed in the hands of the borrower, not the lender.

BUT in order to avoid the attribution of income on the loaned funds and any property purchased with the loaned funds, the interest has to be payable, and actually be paid, no later than 30 days after the end of the taxation year. Accordingly, interest on all interfamily loans designed to split income must be paid on or before January 30th of each year (not January 31st!!). If the loaned funds were used to buy new common shares of a company, the loan might only be a few hundred dollars and the interest may seem insignificant - it is often less than a dollar, particularly if the loan to purchase shares was made late in the year. If the interest is not actually paid, no matter how insignificant, there will be attribution on the income generated by the loaned funds. At the risk of belabouring the point, no matter how insignificant, this interest must be paid by January 30th and a paper trail should be kept. Not only should paperwork be kept to show the payment, but the lender should be including the interest received in his or her tax return for the year of receipt of the interest. A lot of good, and expensive, tax planning could go out the window for the lack of paying two or three dollars of interest.

There is another problem that can arise of the interest is not paid. Many taxpayers establish family trusts for the benefit of their various family members. At the end of 21 years, a trust is deemed to sell all of it property at fair market value, and a substantial taxable capital gain can arise. One of the solutions to this is to transfer the assets out of the trust to the beneficiaries. As long as the beneficiaries are residents of Canada for tax purposes, this can generally be done at the tax cost of the assets, without triggering any capital gain. BUT, if the interest on the loan has not been paid, EVERY YEAR, the ability to transfer the property out of the trust at its tax cost will be lost.

For those situations where the loan was $100 to purchase shares in a family company, the best course is to pay a dividend to the trust as soon as possible to repay the loan in full with interest, so there is no risk of forgetting in future years. But if the loan remains outstanding, don't forget the interest payments.

Ontario Corporations Rule Changes

There are two new provisions that must be kept in mind for Ontario corporations that own real property.

Real Property Register

In a corporation's minute book, there are registers to record directors, officers, shareholders, share transfers and debts of the corporation. The Business Corporations Act has been amended to require a corporation to also keep a register of its interest in real property - registered and unregistered interests.

This new register must be kept at the corporation's registered office address and available for examination to all directors, registered and beneficial shareholders and creditors of the corporation during normal business hours. Such persons are also entitled to take extracts of such records free of charge.

Corporations who fail to comply with these requirements may be subject to a fine up to $25,000. If a Corporation is found guilty, every director or officer who authorized, permitted or acquiesced in the offence is also liable to a fine of up to $2,000 and/or imprisonment for a term of not more than 1 year.

Existing Ontario corporations will have a 2 year grace period and will not be required to maintain a register of real property owned by the corporation and the related supporting documents until December 10th, 2018. However for any Ontario corporations incorporated after December 10th , 2016, these obligations come into effect immediately.

The companies that supply minute books have already included this register in any new books that are ordered.

Forfeiture of Property on Dissolution

Under existing legislation, if a corporation is dissolved, voluntarily or involuntarily, its property is forfeited to the Crown. Corporations are often dissolved for failing to file corporate tax returns.

Although the current legislation provides that the property is forfeited immediately, if the corporation is revived within 20 years after dissolution, it can re-acquire its property.

Under the amendments, the corporation can only re-acquire its property within 3 years of dissolution. Not only is the Crown entitled to treat the property as its own after 3 years, it has the right to delete or amend encumbrances, including mortgages registered against the title.

If you have been notified of the dissolution of your corporation, whether for failing to file or otherwise, immediate steps should be taken to ensure that your property is not lost.

For lenders, it is important to require annual evidence that the corporation is in good standing, to avoid having the Crown take the property and delete your mortgage.

I will you all the best for a happy, healthy and prosperous New Year.

Chuck

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