TAXATION SUMMARY (PROF. ALLARD) - F10
TABLE OF CONTENTS
Introduction ...............................................................................................................3
The tax base ................................................................................................................................................................3
The tax-filing unit .....................................................................................................................................................4
The rates of tax ..........................................................................................................................................................4
Income Tax Terminology.......................................................................................................................................4
Interpretation of tax statutes...............................................................................................................................5
Source concept of income ...........................................................................................6
The role of the courts in defining sources of income .................................................................................6
Nexus between a taxpayer and a source of income....................................................................................8
Who is subject to Canadian income tax? .....................................................................8
Residence .....................................................................................................................................................................9
Case law principles ...................................................................................................................................................... 9
Deemed Residence ....................................................................................................................................................... 9
Part-Time Residence.................................................................................................................................................10
Ordinarily Resident ...................................................................................................................................................10
Corporations and trusts ..........................................................................................................................................11
Income from office or employment ........................................................................... 12
Employee vs. independent contractor .......................................................................................................... 12
Attempts to avoid characterization as an office or employment ....................................................... 14
Inclusions .................................................................................................................................................................. 14
In respect of, in the course of, or by virtue of an office or employment ............................................15
A benefit of any kind whatsoever .......................................................................................................................15
Valuation .......................................................................................................................................................................16
Allowances ....................................................................................................................................................................17
Deductions ................................................................................................................................................................ 18
Travelling Expenses (ss. 8(1)(e), (f), (g), (h), (h.1), (j); 8(4)) ................................................................18
Legal expenses (s. 8(1)(b)) ....................................................................................................................................19
Professional and union dues (ss. 8(1)(i)(i), (iv), (v); 8(5)) .....................................................................20
Income from business or property............................................................................. 20
Income from a business ...................................................................................................................................... 21
Organized activity .....................................................................................................................................................21
The pursuit of profit..................................................................................................................................................21
Adventure or concern in the nature of trade ................................................................................................22
Income from property ......................................................................................................................................... 22
Concept of property ..................................................................................................................................................23
Income from property vs. capital gains ...........................................................................................................23
Interest income ...........................................................................................................................................................23
Rent and royalties ......................................................................................................................................................24
Dividends........................................................................................................................................................................25
Deductions ................................................................................................................................................................ 25
Business purpose test ...............................................................................................................................................25
Personal and living expenses ................................................................................................................................25
Childcare expenses ......................................................................................................................................................... 26
Food and beverages ........................................................................................................................................................ 26
Commuting expenses ..................................................................................................................................................... 27
Home Office Expenses ................................................................................................................................................... 27
Entertainment and business meals ......................................................................................................................... 28
Education Expenses ........................................................................................................................................................ 28
Public policy .................................................................................................................................................................28
Illegal businesses ............................................................................................................................................................. 28
Fines and penalties ......................................................................................................................................................... 28
Interest ............................................................................................................................................................................28
Limitations on deductibility ..................................................................................................................................31
Computation of profit and timing principles .............................................................. 32
Relevance of financing accounting ................................................................................................................. 32
Tax accounting ........................................................................................................................................................ 32
Timing ........................................................................................................................................................................ 33
Recognition of revenue ............................................................................................................................................33
Recognition of expense ............................................................................................................................................34
Modifications ...............................................................................................................................................................34
Advance payments for unearned income or prepaid income ...................................................................... 34
Prepaid expenses ............................................................................................................................................................. 34
Reserves ............................................................................................................................................................................... 34
Capital cost allowances ................................................................................................................................................. 35
Inventory ............................................................................................................................................................................. 35
Modified accrual for professionals: section 34 election ................................................................................. 35
Inventory................................................................................................................................................................... 36
Capital expenditure............................................................................................................................................... 36
Current expenses vs. capital outlays .................................................................................................................36
Tangible assets .................................................................................................................................................................. 36
Intangible assets............................................................................................................................................................... 36
Repair of tangible assets ............................................................................................................................................... 37
Capital cost allowance.............................................................................................................................................37
Calculation .......................................................................................................................................................................... 38
Disposition of depreciable assets (recapture or terminal loss) .................................................................. 39
Replacement property rules (re CCA) .................................................................................................................... 39
Rental and leasing property restrictions .............................................................................................................. 40
The meaning of “cost” .................................................................................................................................................... 40
When is depreciation property acquired? ............................................................................................................ 40
Eligible capital expenditures (ECE)...................................................................................................................41
Taxation of capital gains and losses ........................................................................... 42
Capital gains/losses vs. adventure or concern in the nature of trade ............................................. 42
The capital gains framework ............................................................................................................................ 45
Cost ...................................................................................................................................................................................45
Capital cost and actual cost ......................................................................................................................................... 45
Cost of Property Acquired Before 1972................................................................................................................. 46
Deemed cost of property acquired after 1971 ................................................................................................... 47
Adjustments to cost ........................................................................................................................................................ 47
Disposition and proceeds of disposition (including involuntary dispositions and reserves) ..48
Transactions that are not dispositions .................................................................................................................. 49
Deemed disposition ........................................................................................................................................................ 49
Timing of dispositions ................................................................................................................................................... 49
Part dispositions .............................................................................................................................................................. 50
Combined proceeds for more than one property .............................................................................................. 50
Rollover treatment on the reinvestment of proceeds in a replacement property ............................. 51
Other rollover transactions (farm prop, spouses, donation of capital prop, capital prop vs.
shares) .................................................................................................................................................................................. 51
Reserves for future proceeds ..................................................................................................................................... 51
Expenses of disposition ............................................................................................................................................53
Capital losses ................................................................................................................................................................53
Non-recognition of capital losses (depreciable prop, PUP and LPP, superficial losses) .................. 54
Capital gains deduction (lifetime capital gains exemption on small business corps or
farm/fishing prop) ....................................................................................................................................................55
Intra-family transactions (gifts and non-arm’s length transactions) ...............................................55
Realization vs. rollover treatment............................................................................................................................ 56
Gifts and non-arm’s-length transactions ............................................................................................................... 56
Spousal transfers (rollover) ........................................................................................................................................ 56
The family home and “change of use” rules ...................................................................................................57
Deemed disposition on change in use .................................................................................................................... 58
Identical properties (s. 47) ....................................................................................................................................58
Subdivision e deductions........................................................................................... 58
Calculation of taxable income (overview) .................................................................. 60
From net income to tax ............................................................................................. 63
Carry-over of losses .............................................................................................................................................. 63
Tax credits ................................................................................................................................................................ 63
Charitable donations ................................................................................................................................................64
Medical Expenses .......................................................................................................................................................64
Tuition and education .............................................................................................................................................65
INTRODUCTION
Almost every social and economic policy has a tax angle. The public debate over the federal budget
and related tax changes every year is about the closest Canadians get to a national conversation
about our collective goals and values. No other public policy issue has been so consistently at the
center of ideological conflict over the proper role, size, and functions of the modern welfare sate.
Although money is not everything—we are told—it appears that most people think it is not without
its advantages. So what is a morally acceptable distribution of the income and wealth that members
of a society collectively produce?
The tax base
The tax base is the amount, transaction or property upon which the tax is levied. There are three
main tax bases: income, consumption, and wealth (i.e., property). The federal Income Tax Act is, of
course, concerned with the first of these as imposed by the federal government.1 Broadly speaking,
1
For more detail about the other two tax bases, see handbook p. 16
Summary by Pascal Archambault-Bouffard for Allard’s Fall 2010 Taxation course
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income refers to the net amount an individual earns from sources such as employment, property and
business. Personal income tax accounts for over one-half of federal government revenue.
The tax-filing unit
The government assesses income tax on the basis of each person—individuals and corporations.
Partnerships are not legal persons and therefore cannot be tax-filing units (i.e., the partners file
returns individually). The only exception is with regards to trusts: though not legal persons, they pay
tax as well. In Canada, spouses file separate tax returns, as do children.
The rates of tax
In addition to their base, taxes may also be classified by reference to their rates. There are several
concepts of tax rates, most notably: statutory, marginal, average, and effective rates.
The statutory rate structure is straightforward and is set out in section 117 of the ITA. It
contains four brackets: 15% for taxable income up to $40,726; 22% on additional taxable income up
to $81,452; 26% on additional income up to $126,264; and 29% on additional income above the
latter amount.2 Section 118 provides for a personal tax credit expressed as 15% of $10,320—and, as
a result, excludes tax liability for income up to that amount.
The rate of tax that applies to the next dollar a taxpayer earns is called the marginal rate of
tax, while the rate that is applicable to the taxpayer’s taxable income as a whole—i.e., the fraction of
total taxable income that is paid in taxes—is called the average rate. The effective tax rate is similar to
the average tax rate, but while the latter is computed by reference to taxable income, the former
takes into account tax exemptions, deductions and credits.3
In relation to their rates, taxes are commonly classified as being progressive, proportional or
regressive. A progressive tax is one where the proportion of income paid in taxes rises with income,
whereas a proportional tax takes a constant proportion of income, and a regressive tax takes a
declining proportion. All taxes in Canada are regressive except the income tax, which is progressive.
Overall, the Canadian tax system is about proportional (at 30-35% regardless of income) because the
progressivity of the income tax is generally offset by the regressivity of the other taxes.
Income Tax Terminology
Tax exemptions are amounts that simply do not enter the computation of income—either because the
courts have held that they do not fit within the concept of income as used in section 3 (e.g., strike pay,
gambling gains, gifts and inheritances, windfalls, and personal injury awards, etc.) or because they
ITA specifically exempts them from tax (one-half of any capital gain, for instance). With progressive
tax rates, as in Canada, exempting amounts from income has much greater value to high-income
earners that to low-income earners because the amounts would otherwise have been subjected to
higher tax liability for high-income earners.
Tax deductions are amounts that act to offset against the taxpayer’s income before applying
the tax rates. Taxpayers earning business or property income will be able to deduct all expenses that
were incurred in order to earn the income (e.g., wages paid to employees). Subdivision e allows for
certain personal expenses or investments to be deducted (RRSPs, spousal support payments, moving
expenses, child care expenses, etc.). Division C allows for the deduction of a few additional amounts,
which we do not need to look into for this course. As with exempted amounts, deductible amounts
yield greater benefit to higher-income earners because of the progressive marginal rates of the ITA.
Tax credits are amounts that are offset directly against the taxpayer’s tax liability. Thus,
unlike tax deductions, their value does not depend upon the taxpayer’s marginal rate. The ITA
contains four refundable tax credits, all others being non-refundable—which means that if the
taxpayer’s tax credits exceed the tax that is otherwise owed, the government does not make a
payment to the taxpayer. However, we will not look at specific tax credits in this course.
2
3
These rates are, of course, only the rates of federal income tax.
For computation examples, see handbook p. 18-19
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Summary by Pascal Archambault-Bouffard for Allard’s Fall 2010 Taxation course
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Finally, the Act contains a great number of provisions the purpose of which is to provide
implicit subsidies to taxpayers to encourage them to engage in particular types of activities or to
provide particular taxpayers with a transfer payment. These provisions are widely referred to as tax
expenditures. Again, we will not look at any specific such provision.
Interpretation of tax statutes
Until the mid-80’s, tax legislation was interpreted strictly. Equitable construction was considered
inadmissible, and the court simply adhered to the words of the statute (Partington, 1870; Cape
Brandy, 1920). The effect of strict interpretation is that ambiguities in the charging sections of the
taxing statute are to be resolved in favor of the taxpayer, while ambiguities are to be resolved in
favor of the government when a taxpayer seeks to claim an exemption, deduction or credit
(Witthuhn, 1957). In Witthuhn, the taxpayer sought to deduct expenses of a full-time attendant for
his spouse. Such expenses were deductible under subparagraph 27(1)(c)(iv) of the 1952 ITA if the
spouse was “necessarily confined by reason of illness, injury or affliction to a bed or wheelchair.” The
taxpayers’ spouse could sit for a few hours each day in a special rocking chair designed for her, but
was otherwise confined to bed. In denying the deduction, the court stated that “however much one
may consider that, in equity, a taxpayer should be entitled to a deduction in circumstances such as
those present in this appeal, nevertheless if those circumstances do not coincide with the strict
wording of the legislation, this Board has no jurisdiction to extend the provisions of the statute by
granting the deductions claimed.” However, the modern approach is different. For instance, in JohnsManville, 1985, the SCC indicated that all statutory ambiguities, even those in exempting clauses,
should be resolved in favor of the taxpayer.
The modern and more liberal interpretive approach to taxing statutes was first advanced in
Stubart, 1984, where the court adopted the modern rule of statutory interpretation, stating that “the
words of the Act are to be read in their entire context and in their grammatical and ordinary sense
harmoniously with the scheme of the Act, the object of the Act, and the intention of Parliament.” This
approach, however, leaves unclear what relative weight should be given to the ordinary meaning,
context and purpose—hence the SCC later specified that when an ordinary reading of the stature
provides a clear outcome, a contextual analysis is not necessary (Antosko, 1994). This was dubbed
the plain meaning rule. Then, in Notre-Dame, 1995, the court took a teleological approach, beginning
with the underlying purpose of the legislative provision under consideration, and then interpreting
the words of the provision in a manner that best accomplished this purpose. In Friesen, 1995, the
SCC reverted to the plain meaning approach as expressed in Antosko, and subsequent cases have
tried to reconcile both approaches. Finally, in Trustco, 2005, the SCC revisited the modern approach,
and established that “the interpretation of a statutory provision must be made according to a textual,
contextual and purposive analysis to find a meaning that is harmonious with the Act as a whole. When
the words of a provision are precise and unequivocal, the ordinary meaning of the words plays a
dominant role in the interpretive process. On the other hand, where the words can support more
than one reasonable meaning, the ordinary meaning of the words plays a lesser role. The relative
effects of ordinary meaning, context, and purpose on the interpretive process may vary, but in all
cases the court must seek to read the provisions of an Act as a harmonious whole.” Yet, the relative
emphasis that a court places on text, context and purpose remains problematic to this day. Further,
while the court in Trustco said the ITA is to be “interpreted in order to achieve consistency,
predictability and fairness so that taxpayers may manage their affairs intelligently,” the only
consistent thing about the courts’ comments about statutory interpretation is the lack of analysis to
support the conclusion that a particular approach is appropriate: the views of judges range from
strict interpretation to the modern approach to something in between, and all of these approaches
may be called the “plain meaning approach” by judges (Arnold). A good example of this is the WillKare, 2000, decision, where a taxpayer operating a paving business built a asphalt plant, and asked
for a preferential tax treatment that was dependent on the plant being used primarily for the
purposes of the manufacturing or processing goods for sale or lease. His claim was denied because
most of the asphalt from the plant was used by the taxpayer in its own business (as goods supplied
through contracts for work and materials) and was not therefore “goods for sale,” based on a narrow,
legal definition of sale. The dissent emphasized that the plain meaning of sale would allow the
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deduction. Both the majority and minority relied on the modern approach to statutory interpretation
and both considered the intent of parliament, and yet reach opposite conclusions.
Three statutes—the federal and provincial Interpretation Acts, the Official Languages Act and
the Charter of Rights and Freedoms—affect the interpretation and application of statutes in Canada.
While the federal Interpretation Act says that “every enactment is deemed remedial, and shall be
given such fair, large and liberal construction and interpretation as best ensures the attainment of its
object,” this statement has been largely ignored in the interpretation of income tax legislation. On the
other hand, due to the Official Languages Act, the courts have in several cases been able to use one
version of a statute to enlighten the reading of the other version (see Levine, 1995, for example).
Finally, in a number of cases, taxpayers have challenged the various provisions of the Act as
discriminatory under subsection 15(1) of the Charter, but in most cases they were unsuccessful (e.g.,
Symes, 1994, Thibodeau, 1995).
SOURCE CONCEPT OF INCOME
The definition of income is circumscribed, in Canadian tax law, by the “source doctrine.” The income
tax system’s structure requires the various items of revenue received by a taxpayer to be allocated to
a source inside or outside Canada that is either expressly enumerated in the Act—such as office,
employment, business and property—or recognized by the case law (that is, not enumerated in the
act). The application of the source concept of income means that an amount received by a taxpayer
that has no recognized source is not taxable, while a loss that is not from a recognized source is not
deductible.
Briefly, the taxpayer’s income for the year is the total of the net income (or loss) from each
source, plus net taxable capital gains (section 3). Because of this aggregation, a loss from one source
may offset income from another source. Subdivision d (in particular section 56) includes in income
certain specific types of receipts such as pension benefits, employment insurance benefits, amounts
received from an RRSP, retiring allowances, scholarships and bursaries, which otherwise might not
be considered attributable to a source. Subdivision g (section 81) excludes certain amounts from
income based on social policy concerns, but we will not look at them in this course.
We must also distinguish clearly between the “source” and the “income.” For example, a
capital asset that produces income is considered to be a source of income, while the recurring income
that flows from its exploitation is income from a source. A capital gain or loss—of which only half is
taxable, unlike income from a source—is realized on the sale (or other disposition) of a capital asset;
that is, it results from the disposition of the source itself.
The role of the courts in defining sources of income
Since the ITA does not define income, the courts have played a critical role in determining what
amounts are to be considered income form a source. In Bellingham, 1996, the court noted several
exclusionary categories: gambling gains, gifts and inheritances, and residual category of windfall
gains. It was determined that compensation for expropriation was income from a source, but that
punitive damages award were not because it had no compensatory element, and fell simply in the
tax-exempt category of windfall gains. The reason for these exclusions is that these are items that do
not flow from a productive source—they do not involve the creation of new wealth—and there is no
quid pro quo to their receipt.
It is not hard to determine what is inherited and what is not, but the scope of the other
categories is sometimes difficult to make out. In Cranswick, 1982, an unsolicited payment to a
minority shareholder—made to thwart possible litigation arising from the sale of part of the
company’s assets below book value—was considered “not taxable because it ‘was of an unusual and
unexpected kind that one could not set out to earn as income from share,’” and therefore a windfall
gain. The court then referred to several indicia, though none determinative, to be applied when
assessing whether a receipt constitutes income from a source:
Whether the taxpayer had an enforceable claim to the payment (Cranswick did not)
(a) Whether there was an organized effort on the part of the taxpayer to receive payment (there
was none from Cranswick)
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(b) Whether the payment was sought after or solicited by the taxpayer in any way (it was not by
Cranswick)
(c) Whether the payment was expected by the taxpayer, either specifically of customarily (it was
not by Cranswick)
(d) Whether the payment had a foreseeable element of recurrence (it did not in Cranswick)
(e) Whether the payer was a customary source of income to the taxpayer (it was not in
Cranswick)
(f) Whether the payment was in consideration for or in recognition of property, services or
anything else provided or to be provided by the taxpayer; or whether it was earned by the
taxpayer, either as a result of any activity or pursuit of gain carried on by the taxpayer or
otherwise (it was not in Cranswick)
Although it was not pursued on appeal, one argument could have been that the payment in Cranswick
was made in return for relinquishing the right to seek compensation for losses suffered as a result of
the disadvantageous sale; thus there was a quid pro quo. Moreover, “monies paid in exchange for the
discharge of even a questionable legal right may constitute income in the hands of the taxpayer”
(Bellingham).
In Curran, 1959, the taxpayer received a payment from a third party as an inducement to
leave his present employment (the taxpayer was to be subsequently employed by the third party).
The agreement stipulated that the payment was “in consideration of the loss of pension rights,
chances for advancement, and opportunities for re-employment.” The SCC determined that the
source of the payment was the taxpayer’s employment with the third party (even though he hadn’t
started working there yet) and held it as income from a source. In other words, while the payment
was not, strictly speaking, income from employment, since the taxpayer’s employer had not paid it, it
was nonetheless assessed as constituting income from a source.
In Fries, 1990, the SCC held that strike pay does not constitute income from a source under
3(a). At the time of the decision, it was unclear whether strike pay was income from a source, and the
analysis offered by the SCC was limited to the conclusion that “the benefit of the doubt must go to the
taxpayer.”
Back to Bellingham, the court further elaborated in that case that a critical factor in
determining if something is income from a source is whether it flows from either the performance or
breach of a market transaction (a voluntary one or not). In Bellingham, for instance, the payment in
question did not flow from either an express or implied agreement between the parties, there was
clearly no bargain or exchange, no consideration—no quid pro quo.
The surrogatum principle states that amounts that are received by a taxpayer in the place
of income from a source may be included in come as if such amounts were income from that source.
It is applied, for instance, in the case of amounts received as civil damages, or amounts paid in
settlement of a claim for breach of contract or tort, where such amounts are found to be surrogates
for income from a source. For instance, the surrogatum principle was not applied in Schwartz, 1996,
to a sum received as compensation for anticipatory breach of an employment contract because the
court held that the amount paid to the taxpayer was primarily to compensate the taxpayer for
embarrassment, anxiety and inconvenience (which is not taxable), and did not derive from an unenumerated source akin to a wrongful dismissal compensation or a retirement allowance. The court
in that case stated that it would not give precedence to a general provision where there is a detailed
provision already enacted to deal with a payment such as the one under consideration. Because there
was a specific provision (section 56) dealing with wrongful dismissal payments and retiring
allowances, it was under this provision that the payments made to Schwartz were to be assessed, and
not under the general provision of 3(a). Because Schwartz was not technically “in the service” of
Dynacare yet, the court held that he did not “lose” employment or “retire,” and thus the payment fell
outside the scope of section 56 as well. Another element to take from Schwartz is that courts are
reluctant to add a new source to the list of un-enumerated sources because “it is hardly the role of
the judiciary to do so” and thus a court “should only do so in circumstances which warrant such a
decision because such a result is of fundamental importance.” In Tsiaprailis, 2005, the taxpayer
disputed the inclusion in her income of a portion of a lump sum paid to her to settle a law suit in
which she claimed entitlement to continued benefits under a disability insurance policy provided by
her former employer. The court allowed the inclusion because the amount (a) was intended to
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replace past disability payments, and (b) such payments would have been taxable. Likewise, in
Manley, 1985, the surrogatum principle was applied to treat an award of damages for breach of
warranty of authority as income of the taxpayer. The taxpayer had contracted to receive a finder’s fee
in connection with the sale of a business with a person who had no authority to make the contact to
pay the finder’s fee. The finder’s fee would have been taxable.
All amounts whatsoever that qualify as special or general damages for personal injury or
death will be excluded from income. However, an amount that can reasonably be considered to be
income from employment rather than an award of damages will not be excluded from income (IT365R2).
At last, it is to be noted that when the Minister has, in his pleadings, disclosed the
assumptions of facts on which the assessment was made—and when it is not contested that the
assessment was in fact based on those assumptions—the taxpayer has the onus of disproving the
Minister’s assumptions (Thompson, 1946, Yougman, 1990). The government, however, does not
benefit from such a presumption for its alternative arguments.
Nexus between a taxpayer and a source of income
The income calculation rules in the ITA attempt to resolve three basic questions:
(1) What amounts of revenue must be recognized?
(2) What amounts of expenses are recognized as deductible?
(3) When must the relevant amounts be recognized?
We are concerned in this segment with the first of these questions. In order for the amounts to be
recognized, they must obviously be attributable to an identified taxpayer. The calculation rules for
the four conventional sources of income—employment, business, property and capital gains or
losses—arguably suggest the broad contours of the nexus sufficient to attract tax liability. Income
from employment is taxable to the individual who receives it, which is usually the individual who
earned it through the provision of his or her services. Income from business or property is defined as
“the profit therefrom,” which suggests that the provider of services or the owner of the property is
taxable on revenue from the provision of the services or the holding of the property. Capital gain or
loss of a taxpayer is defined as the gain or loss from the disposition of property, which suggests that
the owner of the property, who generally controls its disposition, must recognize the gain or loss.
Here are two examples: in Field, 2001, the taxpayer’s estranged wife forged RRSP
withdrawal forms in his name to withdraw funds from his RRSP, which were paid into their still-open
joint account—she then withdrew the funds. The court held that Mr. Field was not liable for the tax
on the RRSP withdrawals because one “cannot see how the appellant—in the plain and ordinary
sense—‘received’ any amounts as ‘benefits out of or under’ an RRSP within the language used in
subsection 146(8) of the Act.” In Buckman, 1991, the taxpayer had embezzled funds from his clients,
and the court decided that the fraudulently obtained funds were income, and that Buckman could be
taxed on it, even though he was not, strictly speaking, the legal owner of the funds. The court held
that “the strict legal ownership is not the exclusive test of taxability” and that “a Court in determining
what is income for taxation purposes must have regard to the circumstances surrounding the actual
receipts of the money and the manner in which it was held.” The fact that the funds could be treated
as income flew from the realities of the situation. In other words, “if it is a material acquisition which
confers an economic benefit on the taxpayer and does not constitute an exemption—e.g., a loan or
gift—then it is within the all-embracing definition of section 3.”
WHO IS SUBJECT TO CANADIAN INCOME TAX?
Residence is the principal basis for income taxation in Canada. Residence consists of present ties (but
not necessarily physical ties) to a jurisdiction. Canadian residents are taxed on their worldwide
income: Canada imposes tax on the income earned by residents who work in foreign countries, or
carry on business or receive income from investments in foreign countries. In addition, Canada
imposes tax on any person who is employed in Canada, carries on business in Canada, or receives
income from sources in Canada.
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Section 149 of the ITA exempts from tax certain specified persons—notably, municipal and
provincial corporations, registered charities, non-profit organizations, and labor organizations. Also,
81(1)(a) exempts certain amounts, but we will not study them in this course.4
Residence
Under 2(1) ITA, the worldwide income of taxpayers who are resident in Canada at any time in a
taxation year is subject to tax. In contrast, non-resident taxpayers are liable to tax only on income
from Canadian sources under 2(3) and Part XIII of the ITA. The impact of 2(1) on individuals is
reduced by the operation of the part-time residence rules in section 144. A person may be resident
in Canada for only a part of a year, in which case the person will only be subject to Canadian tax on
his or her worldwide income during the part of the year in which he or she is resident, and taxed as a
non-resident during the other part. As it turns out, an individual may be considered a resident in
more than one country and therefore subject to double taxation—tax treaties and 250(5) ITA come
into play in order to avoid that. IT-221R3 provides an accurate summary of the elements
determining residential status.5
Case law principles
Residence is a question of fact and depends heavily on context since the terms “residing,” “residence”
and “ordinarily resident” have no special or technical meaning. Indeed, in Thomson, 1946, the court
stated that residence is a flexible concept as “it is impossible to give a precise and inclusive
definition” to residing, while ordinarily resident simply refers to the “general mode of life.” It noted
further that “residence” is to be distinguished from a mere “stay” or “visit,” and also noted that, for
income tax purposes, “it must be assumed that every person has at all times a residence.” In this case,
the court found the taxpayer to be a Canadian resident even though he spent more time in the USA
than in Canada, saying that his living in Canada was substantially as deep-rooted and settled as in the
USA, and that mere limitation of time (or mere precedence in time of a residence abroad) did not
qualify that fact.
In Denis M. Lee, 1990, the court stated that “the question of residency is one of fact and
depends on the specific facts of each case” and provided several indicia, though none determinative,
for determining residency.6 It further noted that while “intention, or free choice, is an essential
element in domicile,” it is “entirely absent in residence.” In this case, a British national working
outside Canada who regularly visited in Canada was found to be a resident of Canada (for tax
purposes) after marrying a Canadian and guaranteeing a mortgage on their matrimonial home. The
court said that “although marriage can be a neutral factor, in this case it is the additional factor that
tips the scales from one of non-residency to one of residency.” It was also significant that Mr. Lee was
found not to be a resident elsewhere. Contrast this case with Schujahn, 1962 (see below), and Shih,
2000, where the taxpayer was found not to be a resident of Canada even though his wife and three
sons lived in Regina in a family home owned jointly by Mr. Shih and his wife. Mr. Shih explained that
he and his wife brought their sons to Canada so that they would receive a Western education, and
that that was the only reason for the family coming to Canada while he maintained his employment
as a pharmacist in Taiwan and rarely visited his family. The court agreed that he was a non-resident,
finding that “on the evidence, [Mr. Shih] was a stranger to Regina.” Finally, in Fisher, 1994, what
tipped the scale was the fact that the taxpayer “had a right to come home whenever he chose [and
that] that can be said of no other country” (compare this with Schujahn).
Deemed Residence
An individual who is not resident in Canada under the case law principles may be considered
resident by virtue of the deeming provisions in subsections 250(1) and (2). Paragraph 250(1)(a)
deems an individual to be resident in Canada for the entire taxation year if he or she sojourned in the
country for a period or periods aggregating 183 days or more in the calendar year. In R&L FOOD, 1977,
See handbook p. 206 for more detail on persons exempted from tax liability
See handbook p. 154-158
6 See handbook p. 148 for the list of indicia. First 7 ones are the most important.
4
5
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the shareholders wanted to benefit from a small-business tax exemption available only to Canadiancontrolled companies and, therefore, claimed residence in Canada. Though the applicants spent more
than 183 days in Canada, they came only to Canada for work purposes, and would otherwise be in
the USA. The court pointed out that while sojourning does not approximate residence (it is
something less), it nonetheless requires some links and ties to the communities visited. On the
evidence, the court found that the “home and social ties for each [shareholder] were clearly in
Michigan [where they were resident] and not in [Canada].” It is to note that, for the purposes of
counting the 183 days, sojourning for a day required only that a person spend a part of the day in
Canada (IT-221R3). Alternately, when a person only sleeps in the USA and comes to Canada for all
other purposes, that person remains a resident of Canada (Shpak).
According to IT-221R3, the most important factor in determining whether or not an
individual leaving Canada remains a resident in Canada for tax purposes is whether or not the
individual maintains residential ties with Canada while he or she is abroad. Residence status is
determined on a case-by-case basis after taking into consideration all of the relevant facts—yet,
unless an individual severs all significant residential ties with Canada upon leaving, that person will
continue to be a resident of Canada. The residential ties that will almost always be significant are: (a)
the dwelling place(s); (b) a spouse or common-law partner in Canada; and (c) dependents in
Canada.7
Part-Time Residence
Section 114 provides special rules for calculating the taxable income of an individual who is resident
in Canada during only part of a taxation year. In order for an individual to establish part-time
residence in Canada, the facts must disclose either that the individual commenced to reside or ceased
to reside in Canada.
In Schujahn, 1962, the court recognized that “a change of residence depends on facts
external to [one’s] will or desires.” Schujahn had moved to Canada with his family to take charge of a
Canadian subsidiary of an American corporation. He moved back to the USA in August 1957, but his
wife and son remained in Toronto to facilitate the sale of the family home. Schujahn returned to
Toronto only 3 times until the rest of the family moved back to the USA. While the presence of family
may serve to establish residence, and even though Schujahn could return to the house Canada at any
moment as of right, the court held that because Schujahn had cut most of his “social, employment,
and residential ties” with Canada, that evidenced the severing of residence in Canada. In found that
Schujahn resided in the USA, and that the sole purpose for his wife and son remaining in Toronto a
while longer was to facilitate the sale of the house, and nothing more. As for the visits, they were
found to be of such “singular occurrence” and “transitory and incidental nature” that they could not
imply residence.
There are specific rules in section 128.1 regarding the property owned by individuals are
commence or cease to be Canadian residents. 8
Ordinarily Resident
Subsection 250(3) states that a reference to a person resident in Canada includes a person who was
at the relevant time ordinarily resident in Canada. The courts have failed to clarify the relationship
between the meaning of “resident” in subsection 2(1) and “ordinarily resident” in subsection 250(3).
The expression “ordinarily resident” permits the court to review a taxpayer’s activities over a period
of years (Hansen), and the expression is often used to widen the scope of “resident.” In Reeder,
1975, the taxpayer was a Canadian resident and was offered a job that required him to indefinitely
move to France, though he was expected to return. The court held that temporary stays abroad do
not terminate a person’s Canadian residence status for tax purposes. Rather, fiscal residence, the
court said, is to be determined by look at such material factors as: (a) past and present habits of life;
(b) regularity and length of visits in the jurisdiction asserting residence; (c) ties within that
jurisdiction; (d) ties elsewhere; and (e) permanence or otherwise of purposes of stay abroad.
7
8
For rules determining residence status, even when one leaves Canada, see handbook p. 154 to 158
See handbook p. 162-163 for these rules
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Further, it noted that the matter of ties within the jurisdiction asserting residence and elsewhere
runs the gamut of an individual’s connections and commitments: property and investment,
employment, family, business, cultural and social, etc. The court, on the premise that everyone must
have a fiscal residence somewhere and that it is quite possible for an individual to be simultaneously
resident in one place for tax purposes, found Reeder to be a Canadian resident, saying that “had the
defendant been asked, while in France, where he regularly, normally or customarily lived, Canada
must have been the answer.” The fact that Reeder did not pay income tax in France made the task
even easier for Canadian courts.
In Midyette, 1985, the court stated that 250(3) is not a deeming provision, but rather serves
to “extend any narrow or limited signification of residence in the sense of actual physical presence at
any given time to the circumstantial concept of the person who has centralized his ordinary mode of
living at some place in Canada or has maintained a sufficient nexus or connection therewith as to be
logically regarded as being ordinarily resident in Canada, even though physically absent therefrom.”
In Laurin, 2007, the taxpayer was an Air Canada pilot. From 1996 to 2000, he did not spend
more than 183 days in Canada in any one taxation year. He had accommodations and financial
investments in Turks and Caicos Islands, a jurisdiction with which Canada has no tax convention. He
had a mailing address, a driver's license, and financial links to Florida. He had employment
obligations, social relations, and professional services connecting him to Canada. The Minister
assessed him for 1996 to 2000 as a resident of Canada, while conceding that he was also a resident of
TCI. The court held that an individual can be a resident of Canada for tax purposes either under the
deeming rules in subsection 250(1) of the Act, or by being “ordinarily resident” in Canada under
subsection 250(3). In cited Thomson, where the SCC held that “one is ‘ordinarily resident’ in the
place where in the settled routine of his life he regularly, normally or customarily lives. One
‘sojourns’ at a place where he unusually, casually or intermittently visits or stays”. The Minister
conceded that the taxpayer did not meet the 183-day sojourning text in paragraph 250(1)(a) of the
Act. Therefore, it was unnecessary to determine whether the taxpayer was “ordinarily resident” in
Canada since this allegation was not pleaded in the Minister's reply. However, on the evidence, the
taxpayer was not “ordinarily resident.” This left for determination the question of how the taxpayer's
Air Canada salary should be allocated to Canada. Formal judgment was deferred for two weeks to
permit counsel for the parties to determine how they wished the allocation issue to be handled by
the Court. (compare with Houser, CN10)
Corporations and trusts
Under the Act, a corporation is considered to be a “person” and a “taxpayer.” The residence of a
corporation is determined by applying statutory rules, case law principles, and tax treaty provisions.
250(4)(a) deems a corporation incorporated in Canada to be resident in Canada throughout a
taxation year. The rule does not apply to corporations incorporated in Canada before April 27, 1965.
These corporations are deemed to be resident in Canada under 250(4)(c) only if, at any time in the
taxation year or at any time in a preceding taxation year ending after April 26, 1965, there were
resident in Canada (presumably under the case law principles) or carried on business in Canada.
Thus, the concept of corporate residence developed in the case law remains relevant for corporations
incorporated in Canada before April 27, 1965 and for corporations incorporated or continued
outside Canada. Canadian courts have held that a corporation is resident where its “central
management and control” is located. The central management and control usually refers to the
exercise of power and control by the board of directors of a corporation, but it is the actual place of
management, not that place in which it ought to be managed, which ultimately fixes the residence of
a company (De Beers, 1906). A corporation can have more than one residence, depending on
whether a court requires merely that some part of the mind and management of the corporation be
located in a jurisdiction, or instead that there be final and supreme authority located in a jurisdiction.
Canadian courts have not indicated clearly which is the preferred approach.
Sections 104 to 108 deal with the taxation of trusts and estates, which are taxed separately
in a manner similar to, but not identical with, the tax treatment of individuals. 9
9
See handbook p. 175 for more detail on trusts
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INCOME FROM OFFICE OR EMPLOYMENT
For income tax purposes, an individual who is retained to provide services to another person is
either an “employee,” and earns employment income, or an “independent contractor,” earning
business income. “Office” is defined in subsection 248(1) ITA, and includes such people as an elected
officer, director, executor, judge, chairperson or union office, etc. Subsection 248(1) also defines the
terms related to employment, but these definitions are not very helpful in determining whether an
individual is an employee or independent contractor.
The difference between and employee and a self-employed person is important because the
former yields employment income and the latter business income, and so different tax rules apply.
The main differences are:
 Payment and withholding of Tax—an employer must withhold and remit a prescribed
amount from each payment made to an employee (section 153). There is no such obligation
for payments to freelancers.
 Basis of measurement—income from office or employment is generally calculated on a “cash
basis,” whereas income from business is calculated on an “accrual basis.” (See timing
principles)
 Reporting period—section 249 stipulates that the taxation year of an individual is the
calendar year. Business income is calculated on the basis of a “fiscal period,” as defined in
section 249.1. However, for individuals (independent contractors) a fiscal period cannot
generally extend beyond the end of the calendar year in which it begins. 10
 Scope of deductions—an employee may deduct the limited set of expenses authorized in
section 8. A self-employed businessperson has considerably wider scope to deduct incomeearning expenses under sections 9 and 20.
Employee vs. independent contractor
The characterization of an individual as an employee or independent contractor is a question of fact.
The traditional master-servant concept and contract of-or-for service test are no longer relevant
today. Rather, it is a balancing operation where the court examines all the possible factors that have
been referred to in case law as bearing on the nature of the relationship between the parties
concerned (Wiebe, 1986).
In Wiebe the court review the jurisprudence, and then decided to look at the “combined force
of the whole scheme operations” in determining the question of whether the party is carrying on the
business for himself or on his own behalf, or for the benefit of a superior. The court acknowledged
several useful criteria—control, ownership of the tools, chance of profit, and risk of loss—which
translate as questions like “whether the man performing the services provides his own equipment,
whether he hires his own helpers, what degree of financial risk be taken, what degree of
responsibility for investment and management he has, and whether and how far he has an
opportunity of profiting from sound management in the performance of his task.” It also noted that it
was appropriate to ask whether, from the point of view of the employed, the services performed
were so performed in the course of a business of his own, hence merely incidental to a larger
business, or as an integral part of that larger business. Finally, while an independent contractor
agreement between the parties will be seriously considered, is not determinative because there are
no strict rules, and “courts are not bound by the intention of the parties to a contract and can
characterize the source of income on the basis of the ‘substance’ of the relationship. Again, the whole
scheme of the relationship must be reviewed, and the list of relevant factors for consideration is not
exhaustive, and different weight is given to different factors depending on the circumstances of each
case. The Wiebe approach was affirmed by the SCC in Sagaz, 2001.
More recently, in Lang, 2007, the taxpayers owned and operated a Saskatchewan-based
furnace and duct cleaning business (“Dun-Rite”), and hired workers to service residences and other
buildings. The taxpayers supplied the vacuum equipment used by the workers, and a truck for each
work crew if required, but the workers supplied their own tools. The workers were paid a
10
For more detail on reporting periods, see handbook p. 220
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percentage of the fees paid to Dun-Rite. The Minister assessed the taxpayers under the Canada
Pension Plan and the Employment Insurance Act on the basis that certain workers they retained
were engaged in pensionable and insurable employment. The taxpayers appealed to the Tax Court of
Canada on the grounds that the workers were independent contractors, and not employees working
under contracts of service. The appeals were allowed: while no single test was held to be
determinative, the factors surrounding the working relationship revealed that the workers were
independent contractors and not employees. The workers were under no supervision or control.
They also had a chance to profit and bore the risk of loss. With respect to intent, the workers
regarded themselves as independent contractors, as did the taxpayers. The court also noted that
while intention of the parties cannot be ignored, it is still uncertain whether it is a predominant
factor (see Royal Winnipeg, 2008, and Décary J.A.’s statements in Wolf, 2002) or merely a tiebreaker
when the factors point in both directions with equal force (see Noel J.A.’s statements in Wolf). In any
case, where intent is a factor in determining the status of a worker, both the employer and the
worker must share the intent.
In Grimard, 2009, the taxpayer was a medical specialist residing in Sherbrooke, but who
worked under contract in Montreal as a medical assessor for an administrative tribunal. The
taxpayer reported his income from his medical assessment work as professional income, from which
he deducted the rental and other expenses incurred with respect to an apartment in Montreal, as well
as the expenses incurred in travelling back and forth between Montreal and Sherbrooke. The court
pointed out that in this context, Quebec law complements the common law, as required by s. 8.1 of
the Interpretation Act. The notion of control is only one of the criteria to be examined in a common
law analysis of the employment relationship, whereas, under Quebec law, control (or
“subordination”) is an essential characteristic in a contract of employment (art. 2085 CCQ), and lack
thereof an essential to self-employment (art. 2099 CCQ). The contract wasn’t clear enough and of no
help in this case, so the court decided to look all the factors provided in federal jurisprudence, as
these are, in the end, indicia of subordination or lack thereof. While Grimard enjoyed relative
freedom in the performance of his work due to his specialized skills, the court found that the
equipment was provided by the administrative tribunal, that his work was integral to the larger
operation of the tribunal, that he did not bear any risk of loss, that his work-related travelling
expenses were paid by the tribunal, and that he was bound by the tribunal’s code of ethics and the
authority of its Commissioner. These factors indicated an element of subordination from Grimard to
the tribunal, which meant that he was an employee.
With an employment contract usually comes a T-4 receipt, showing the taxes and
contributions paid by the employer on the employee’s behalf. Such payments are not necessarily
determinative, but cumulatively they are indicated of the status of an employee and not an
independent contractor (Baxter, 1996). In Moose Jaw, 1988, for example, the taxpayer was found to
have hired employees rather than freelancers even if he made no such payments because the
employment contract, “properly construed,” pointed to a employer/employee relationship. In
Cavanaugh, 1997, the taxpayer had a contract with the university and received T-4 returns, but was
still found to be an independent contractor. The court found that the university had only minimal
control and supervision over the taxpayer’s activities, that the taxpayer supplied his own equipment,
that he was free to set up tutorials off-campus and had to pay for the expenses if he did, that he had
no tenure whatsoever at the university, that he had the right to hire somebody else to do his work,
that he had an opportunity for profit and ran a risk of loss, and that his work was not an integral of
the university’s work in the sense that the work of York could be carried on in the event that he was
not hired, and that he was not paid on a regular basis. The court concluded just because the
university referred to Cavanaugh’s remuneration as employment income does not mean that it was
correct.
Finally, another way sometimes used by courts in characterizing an employment
relationship is the “specific results” test, developed in Alexander, 1969. In that case, a radiologist was
under contract to a hospital and had very specific duties. The court held that he was self-employed
because his contract with the hospital provided for the “accomplishment of a specified job or task”
rather than providing for the disposal of his personal services to the master hospital. This test was
also applied in Hauser, 1978, where it was found that the taxpayer was an employee of the hospital
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partly because, unlike Dr. Alexander, he had to personally perform the work set out in his contract to
the hospital and his personal services were at the disposal of the hospital.
Attempts to avoid characterization as an office or employment
The obvious advantage of an independent contractor being able to deduct business expenses instead
of being limited to the specific deductions in section 8 as an employee had led to certain
arrangement designed to avoid the status of employee. Interposing a contract of service is one way,
but as we know the courts are not bound by the terminology used in the contract and can
characterize the source of income on the basis of the substance of the relationship (see above).
Another way consists in interposing a corporation or trust for the benefit of the employee, shifting
income to the trust or corporation where greater tax planning opportunities exist—however, we will
not look at this in detail. Finally, a third method is to capitalize the employment benefit: convert what
would be income from an office or employment into income from a capital source, which is either
exempt or only partially taxed as a capital gain.
In Curran, 1959, the taxpayer received a payment from a third party as an inducement to
leave his present employment and serve as manager of another company. The taxpayer contended
that the payment represented a capital receipt and not income because it was compensation for loss
or relinquishment of a source of income (the former employment). But the court, while admitting
that the taxpayer obviously had to quit his former employment so as to take on the new one, pointed
out that “the essence of the matter was the acquisition of services and the consideration was paid so
that those services would be made available.” No capital asset was sold or bought. The payment was
included as income (as if from employment) under paragraph 3(a).
Extraordinary payments that occur at the end of employment are included in income under
subparagraph 56(1)(a)(ii), which includes retiring allowances, and subsection 6(3) which can
include in employment income amounts received both before and after the period of actual
employment, so as to defeat a scheme to capitalize an employment benefit.11 In Richstone, 1974, for
instance, that provision was applied to bring into employment income an amount paid, upon the
termination of employment, for a covenant not to compete made by the employee. It was also applied
in Choquette, 1974, to a payment made to an employee on the surrendering of his rights under an
employment contract in return for a “capital indemnity,” although the taxpayer in that case remained
employed by the employer, only in a different capacity. Also, see Schwartz, 1996 (above, p. 7).
Inclusions
Section 5 includes in a taxpayer’s income any amounts received as salary, wages, gratuities
and “other remuneration.” Respectively they include: compensation for services rendered by
employees in the course of their duties; voluntary payments in consideration of services rendered in
the course of office or employment; and honoraria, commissions, bonuses, gifts, rewards, and prizes
provided as compensation for services. Paragraph 6(1)(a) ensures that the value of all benefits (cash
or non-cash) are included in the computation of a taxpayer’s income. 12 It requires the inclusion of
“board,” “lodging,” and “other benefits of any kind whatsoever.” Therefore, other than “board” and
“lodging,” and subject to the exceptions contained in paragraph 6(1)(a)(i) to (v), an amount is
taxable under 6(1)(a) if it is a “benefit of any kind whatsoever” and “received or enjoyed in the year
in respect of, in the course of, or by virtue of an office or employment. If both of these requirements
are satisfied, the “value” of the benefit is include in the taxpayer’s income. Therefore, an economic
advantage received by an employee from his or her employer will be deemed a benefit within the
meaning of paragraph 6(1)(a) unless the employee can demonstrate that the payment was not a
benefit in respect of employment, but made in his or her capacity as a person. The question of
whether a payment is a gift, loan or the result of considerations extraneous to the employment
relationship is often approached with reference to the employer’s intention or the purpose of the
11
12
See handbook p. 265 for detail on section 6(3)
For policy concerns re employment benefits, see handbook p. 240
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payment. Also, a contract is not conclusive of whether a payment is received in the capacity of person
or employee (see Savage or Phillips, below).
In respect of, in the course of, or by virtue of an office or employment
In Savage, 1983, the taxpayer had received money from her employer as a reward for passing the
some examinations related to her field of work. The court noted that the words “in respect of” are
words of the widest possible scope (e.g., it is not restricted to payments in exchange for services
performed by the employee). The court found it “difficult to conclude that the payments by [the
employer] to Mrs. Savage were not in relation to or in connection with her employment […] the
employee took the courses to improve his or her knowledge and efficiency in the company business
and for better opportunity of promotion.” It concluded that the payments received by Mrs. Savage
were a taxable employment benefit. Note, however, that now 56(1)(n) specifically excludes such
awards. In Perry, 1965, the taxpayer had received £10 vouchers from his employer at Christmas. The
court said that while not every sum or other profit received by an employee from his employer in the
course of his employment is to be regarded as arising from the employment, a sum given to an
employee inspired by hope of some future quid pro quo (for instance, good service) is taxable. The
gifts were made to many employees every year, which indicated that the reason why the company
decided to make gifts was in connection to employment, not purely out of benevolence. In Dunlap,
1998, the court recognized a Christmas party held and paid for by the employer as an employment
benefit. In Waffle, 1968, the court recognized a pleasure cruise as a benefit from employment even
though Waffle went on the cruise simply because his boss, who was supposed to go, became unable
to go and offered him the cruise instead. Had Waffle not worked for his boss, he would not have been
offered the cruise.13 (Also see Sorin, CN11).
The government’s policy is that “there is no limit on the number of tax-free non-cash gifts
and awards that an employer can give an employee in a year up to a value of $500” (excess is
included). Gifts have to be for a special occasion (Christmas, birthday, etc.), and an award for an
employment-related accomplishment, but not performance-related (that’s a bonus). The employer
can deduct the fair market value of the gifts.
A benefit of any kind whatsoever
The courts have had difficulty determining whether various apparent economic advantages enjoyed
by employees are taxable benefits. In Lowe, 1996, the taxpayer went on a trip at the demand of his
employer to oversee a group of brokers with whom the employer wanted to strengthen its business
relationship. The court said that in light of the jurisprudence, “no part of [Lowe’s] trip expenses
should be regarded as a personal benefit unless that part represents a material acquisition for or
something of value to him in an economic sense and that if the part which represents a material
acquisition or something of value was a mere incident of what was primarily a business trip it should
not be regarded as a taxable benefit within subparagraph 6(1)(a) of the Act.” The court viewed the
trip not as a combination of business and pleasure, but primarily for business, with only an incidental
element of pleasure. Therefore, it did not recognize the trip as a benefit, and also did not recognize
the trip expenses for Lowe’s spouse, saying that she too was on the trip primarily to serve the
employer’s business.
In Hoffman, 1990, the court confirmed that in order to for something to be a taxable
employment benefit, it is “necessary to consider whether the here show that there was a material
acquisition conferring an economic benefit on the taxpayer.” Hoffman received a sum of $500 to
purchase clothes for work. While the amount was certainly in respect of employment, the court noted
that he was required to wear such clothes for work and that the amount merely served to reimburse
him for that necessary expense: the taxpayer was simply being restored to the economic situation he
was in before his employer ordered him to incur the expenses. There was no benefit. Note that if
Hoffman had not been reimbursed, he would still have been able to deduct the expenses he incurred
as 8(1)(i) allows it for “the cost of supplies that were consumed directly in the performance of the
duties of the office or employment and that the officer or employee was required by the contract of
13
In Waffle, we’re not dealing with random chance. To compare, see p. 254 #6
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employment to supply and pay for […] to the extent that the taxpayer has not been reimbursed, and
is not entitled to be reimbursed in respect thereof.”
In Ransom, 1967, an employee was required to move by his employer and incurred a lost on
the sale of his house. The court mentioned that, economically, all that Ransom received was the
amount that he was out of pocket by reason of the employment, and said that it is “quite clear that
reimbursement of an employee by an employer for expenses or losses incurred by reason of the
employment […] is neither remuneration as such or a benefit ‘of any kind whatsoever.’” Therefore, it
fell outside 6(1). In Phillips, 1994, the taxpayer had moved by reason of his employment and been
given a sum of money to compensate for the increased housing costs at the new location. The court
easily found that Phillips had received the payment in his capacity as employee. Yet, while
reimbursement by an employer for the loss suffered by an employee by reason of his employment is
not taxable to the extent that the payment reflects the employee’s actual loss, Phillips is
distinguishable from Ransom in that Phillips received an economic advantage from the payment. The
amount was not paid to Phillips to provide reimbursement, but rather to allow expenditure. Indeed,
the payment was made to enable him to acquire a more valuable asset, increasing his net worth. The
court also mentioned that “economic benefit” should not be assessed on the basis of subjective
criteria. Finally, he court said that house selection is in great part matter of personal taste and
consumption, and that the government should be careful not to subsidize this choice, which would
create inequities in the tax system.
In Krull, 1996, the court applied Ransom to hold that payments reflecting increases in
mortgage payments at the new location were not taxable, distinguishing it from Phillips because it
did not increase the taxpayer’s net worth. In Gernhart, 1996, the court held that “tax equalization
packages” that reflect higher tax rates at the new location were not reimbursements, but rather a
form of adjusted remuneration.14
Note that subsection 6(23) overturned the outcome of Krull and Phillips: employerprovided housing subsidies are now always a taxable benefit: “For greater certainty, an amount paid
or the value of assistance provided by any person in respect of, in the course of, or because of, an
individual’s office or employment in respect of the cost of, the financing of, the use of, or the right to
use, a residence is, for the purposes of [s. 6], a benefit received by the individual because of the office
or employment.” Likewise, the Ransom-type non-taxable benefits are now capped by ss. 6(19) to
6(22) and the definition of “eligible relocation” in 248(1): employees must include in income onehalf of the amount in excess of $15,000 paid directly or indirectly to an employee by an employer in
respect of a decrease in value or impairment of proceeds of disposition of the employee’s residence.
In Bartley, 2008, the taxpayer's employer awarded to each of three of his children $3,000
under its Higher Education Award Program as partial reimbursement for those children's tuition
fees. In assessing the taxpayer for 2004, the Minister included $9,000 in his income as an
employment benefit. The taxpayer appealed to the Tax Court of Canada, which held that the $9,000
was not an employment benefit in the taxpayer's hands because he personally received no
measurable economic advantage. The $3,000 received by each of the taxpayer's children constituted
income in their hands as scholarships under paragraph 56(1)(n). In Detchon, 1996, the court held
that tuition-free enrolment of employees’ children at a private secondary level boarding school was a
taxable benefit to the employees, since, as parents, they had a personal obligation to pay for the
personal expenses (including schooling) of their children until they are 16 years old. Presumably, the
distinction rests on the assumption that there is financial dependence on the part of children who
attend elementary or secondary school, and that tuition awards in respect of these family members
relieves the employee of what would otherwise be a personal financial obligation. (See CN14)
Valuation
Paragraph 6(1)(a) requires that the “value” of a taxable benefit be included in the taxpayer’s income.
Under Canadian law, that value is generally the fair market value of the benefit, the generally
accepted definition of fair market value being the amount a person not obligated to buy would pay to
a person not obligated to sell (Steen, 1988). In Giffen, 1995, the taxpayers were required to travel
14
For policy concerns, see handbook p. 275
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frequently in the course of their employment, and earned air miles points on employer-paid tickets,
which points were then redeemed for reward tickets which were used by their family members. The
court found that the free travel rewards were benefits under paragraph 6(1)(a) and that they were
“received” when the appellants’ family members travelled free. In terms of valuation, the court said
that the cost to the employer being the proper measure for value of the benefit is only applicable
when the benefits were acquired by ordinary purchase in the open market, which was not the case
here. Rather, the court said that the “proper measure of the value of a benefit in the form of a reward
ticket is the price which the employee would have been obliged to pay for a revenue ticket entitling
him to travel on the same flight in the same class of service and subject to the same restrictions as are
applicable to reward tickets.” In other words, it is the cost of revenue tickets with a discount to take
into account the restrictions on reward tickets.
The government’s current administrative policy with regard to points from reward
programs like Air Miles collected by employees on credit card purchases that are reimbursed by
employers is that no employee benefit has to be included income provided that: the points are not
converted to cash, the plan is not indicative of another form of remuneration, and the plan or
arrangement is not for tax avoidance purposes.
In Yougman, 1990, the taxpayer had a company (the shares of which were fully owned by
him and his family) build a house for his family and then paid rent to that company. He alleged that
the fair market value of the rental of the house did not exceed the rent he had paid and so he received
no benefit from his company. The court said that in this case the benefit conferred was not merely
the right to use or occupy a house, but also to have had that house specially built for him according to
his specifications. It then asked “what price the shareholder would have had to pay, in similar
circumstances, to get the same benefit from a company of which he was not a shareholder,” that is,
where he would deal at arm’s length. Whatever the amount, it would be more that mere free market
rental value.
Placing a value on a taxable benefit is difficult in cases where the item provided to the
employee has a work-related purpose and also provides a personal benefit. The apportionment of
dual character benefits is will illustrated in cases where an employee travels on an employer-paid
trip that has a business purpose and a personal enjoyment component. In Ferguson, 1972, only a
portion of the trip was held as a benefit. The taxpayer was requested to go to Greece for business, and
did so, but also took a number of planned tours in Athens. In Philp, 1970, employees who had met or
exceeded their sales quota were paid a trip to the Caribbean. The only scheduled events on the trip
were three short business sessions, and the president’s dinner. The court decided that a benefit had
been conferred on each taxpayer consisting of one-half of the employer’s cost for each taxpayer’s trip.
What happens when a benefit is provided to an employee but is not used? In Richmond,
1998, the taxpayer was given a parking spot for free, but which he used only 20% of the year, and
therefore argued that he should be assessed for a benefit of 20% of the value of the spot. The court
disagreed: “whether [he] used the property is of little consequence. It was available to him and was
accordingly a benefit to him.” (Compare this with Chow at CN 15.) In Rachfalowski, 2009, the
taxpayer received a golf club membership paid by his employer, but he hated golf. He tried to refuse
the membership, but was persuaded not to do so. He then used it on rare occasions, mainly to
entertain clients or to go eat. This time, the court said that “a benefit under paragraph 6(1)(a) should
be determined on an individual basis of actual use as opposed to availability.” The court found that
the membership primarily benefited the employer, and that, even if that wasn’t the case, the value of
the benefit was minimal at best. In Wisla, 2000, the value of the benefit (a ring given to the taxpayer
by his employer) was reduced to take into account the promotion and marketing element of the ring
(it had the employer’s logo on it).
Allowances
Subject to certain specific exceptions, 15 paragraph 6(1)(b) requires allowances received by a
taxpayer to be included in income from an office or employment.
15
The exceptions are under 6(1)(b)(i) to (ix)
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MacDonald, 1994, is the leading case on what constitutes an allowance under that provision:
first, an allowance is an arbitrary amount in that it is a predetermined sum set without specific
reference to any actual expense or cost (the amount of the allowance may be set through a process of
projected or average expenses or costs); second, it will usually be for a specific purpose (6(1)(b)
encompasses allowances for “personal or living expenses” or “any other purpose”); third, an
allowance is in the discretion of the recipient in that the recipient need not account for the
expenditure of the funds towards an actual expense or cost. In MacDonald, an RCMP officer was
relocated and given a housing subsidy of $700 per month. The court held that it was an allowance
instead of a benefit.
In Campbell, 1955, a nurse was given $50 per month to use her own car to transport goods
and patients to and from the hospital. She claimed that the $50 was monies advanced for the
furnishing of services apart from any office or employment held by her, and that they were rental
payments for the use of her car from which there should be deducted running expenses. The court
found that the transportation of goods and patients was not part of her ordinary duties and
apparently voluntarily performed by her, and that the use of her car for hospital purposes was not
part of her contract nor did it arise out of her duties as Superintendent. Therefore, the $50 was not
on account of remuneration, rental or reimbursement. It was an allowance, paid on a periodic basis.
This case represents the worst-case scenario: the allowance was a taxable benefit, and she could not
deduct the expenses that the allowable was intended to cover under section 8.
In Huffman, 1990, the taxpayer received a sum of $500 to purchase clothes for work. The
court noted that he was required to wear such clothes for work and that the amount served to
reimburse him for that necessary expense. However, Huffman was not required to submit receipts
above $400 even though he would receive reimbursement of $500 (Huffman submitted receipts of
$420.43). The government claimed that the $79.57 balance was a taxable allowance. The court noted
that the rationale for not requiring receipts above $400 was simply to avoid extra paperwork during
the year the $400 reimbursement was increased to $500, and such a policy did not “operate as to
change the nature of the payment. It is still a reimbursement, not an allowance.” The court reasoned
that “an allowance is […] a limited predetermined sum of money paid to enable the recipient to
provide for certain kinds of expense, its amount is determined in advance and, once paid, it is at the
complete discretion of the recipient who is not required to account for it. A payment in satisfaction of
an obligation to indemnify or reimburse someone or to defray his or her actual expenses is not an
allowance; it is not a sum allowed to the recipient to be applied in his of her discretion to certain kinds
of expense.”
Deductions
Section 8 authorizes a number of deductions in respect of employment income. Subsection 8(2)
limits the deductions to those expenses set out in section 8. Section 67 applies to all deductions from
any source including income from an office or employment. The provision states that the amount of
an expense otherwise deductible must also be reasonable. Only the portion of the expense that is
found to be reasonable will be deductible. Section 67.1 restricts food, beverages and entertainment
to 50% of the cost of those items.
Travelling Expenses (ss. 8(1)(e), (f), (g), (h), (h.1), (j); 8(4))
There are several possible arrangements between an employer and an employee concerning the
payment of travel expenses. For instance, the employer may reimburse the employee for the
expenses incurred or may provide an allowance. But what if the employee must pay for travel
expenses out of income? We know that commuting expenses are generally disallowed on the ground
that a taxpayer’s choice of place of residence is a consumption decision. For instance, in Martyn,
1962, the taxpayer wanted to deduct the cost of commuting between his home and his workplace
under paragraph 8(1)(h). The court refused on the basis that the car expenses in question were not
incurred by the taxpayer while he was carrying on the duties of his employment away from his
employer’s place of business, but rather in proceeding from his home to his employer’s place of
business and in returning in due course to his home. The court said that the tax rules applicable to
employees were not the same as those applicable to self-employed persons (who are permitted to
deduct expenses considered reasonable for the purposes of earning income). In Evans, 1999, the
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taxpayer was required to travel from her home to a number of schools each day. She received a travel
allowance, but not for travel to the first school and home from the last school. She claims these
expenses as a deduction under paragraph 8(1)(h.1). She was successful because, given the
circumstances of her employment, she had to store a voluminous amount of documents in her car on
a permanent basis to such an extent that she had no choice but to use her car for employment. In a
sense, her car was also a workstation. Further, the court noted that the provision of a travel
allowance did not preclude the deduction of travel expense provided that the expenses related to
travel are not covered by the allowance. In Little, 1974, the taxpayer lived in Moose Jaw but was
assigned to work in Swift Current at some point. A claim for relief under paragraph 8(1)(g) was
denied on the ground that Swift Current was the location of his “employer’s establishment to which
he reported for work.” In Deimert, 1976, although subparagraph 8(1)(g)(ii) speaks of a taxpayer
who makes disbursements for meals and lodging, the court decided in favor of a taxpayer who had
expenses for meals but not for lodging.
Under paragraphs 8(1)(f), (h) and (h.1), the taxpayer must be “ordinarily required” to carry
on the duties of his employment away from his employer’s place of business; in paragraph 8(1)(g)
the phrase is “required... regularly.” In Ondrey, 1961, a taxpayer who spent two-thirds of each day
travelling was found to satisfy the “ordinarily required” condition. In Klue, 1975, the taxpayer was a
policeman obliged to appear in court whenever he was needed, on or off duty. Under 8(1)(h) he
claimed parking costs and automobile expenses relating to 84 off-duty occasions. The court found
that he was ordinarily required to show up in court as part of his duties, that the court was not his
employer’s place of business, and that such trips were not equivalent to commuting to the police
station. In Patterson, 1982, the court accepted that it was part of the duties of a school principal to
use his car to transport students to various events and competitions, to the hospital, and on camping
trips, and that such travel was “ordinarily required.” In Bubnick, 1981, disallowed deductions to a
school principal whose auto expenses arose from numerous errands that resembled “a pick-up and
delivery service,” saying that the school board did not expect the principal to run such errands. In
Imray, 1984, the taxpayers were teachers who attended an annual convention pursuant to terms of
their employment, and claimed expenses incurred for attending as deductions under 8(1)(h)(i). The
court said that within this context, the fact that the conventions occur only once per year is a minor
factor: the teachers’ attendance a matter of regular occurrence, and it took them away from the
places in which they usually worked. In Neufeld, 1981, “ordinarily required” was held to be an issue
of contractual obligation, and it not proven simply by a percentage argument. The court held that the
requirement in subparagraph 8(1)(f)(ii) that the employee be “ordinarily… away from his
employer’s place of business” must be a clear requirement of the employment contract, just like the
employee’s obligation to pay his own expenses. In Verrier, 1990, the court took a more practical
approach. In that case, the taxpayer was a car salesman and, even though there was no written
employment contract, the could allowed him to deduct certain expenses under 8(1)(f) because he
could only satisfy the sales quota by operating, in part, away from his employer’s place of business.
Legal expenses (s. 8(1)(b))
An employee is entitled to deduct amounts paid on account of legal expenses incurred to establish a
right to salary or wages, as well as to collect any such amount that is owed. Before 1990, you could
only deduct legal expenses incurred to collect. The government’s position is that if the taxpayer fails
to establish that the amount is owed, no deduction for expenses is allowed. Also, there is a difference
between collecting amounts owing and protecting one’s livelihood. For example, in Blagdon, 2003,
expenses incurred by a shipmaster to defend his competence and right to command a ship were
judged non-deductible.
Paragraph 6(1)(j) requires an award or reimbursement received by a taxpayer in respect of
an amount deductible under subsection 8(1) to be included in income unless otherwise included or
taken into account in reducing the amount claimed as a deduction. This provision ensures that legal
expenses are deducted under paragraph 8(1)(b) only to the extent that they represent a cost of
earning income, net of any awards or reimbursements in respect of the expenses.
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Professional and union dues (ss. 8(1)(i)(i), (iv), (v); 8(5))
Paragraph 8(1)(i) provides a deduction for annual professional and union dues. Only annual fees
count—an additional fee upon entry is non-deductible. The professional status or trade union must
be recognized by statute. The deduction is also available to those who are required to pay the dues as
a condition of employment even if they are not union members (8(1)(i)(v)). Subparagraph
8(1)(i)(v) lists a number of union dues for which there is no requirement that they must be paid in
order to obtain or keep employment. Dues used to provide benefits to members, such as malpractice
insurance, are deductible provided that the insurance is required to maintain a professional status
(subsection 8(5)). In Swingle, 1977, the court elaborated on the requirement that the dues be
“necessary to maintain a professional status recognized by statute.” It said that “where a taxpayer’s
income was derived from an office or employment he could deduct dues he was required to pay in
order to exercise the very right to carry on his profession or calling, and thus earn salary or
remuneration,” but that he may also deduct dues when it is “necessary” to belong to organizations in
order to remain qualified, in the practical and business sense; to be able effectively to perform, and
earn income, in a particular profession. The court gave the example of an accountant who, while not
required to pay annual dues to, say, the Institute of Chartered Accountant, might still find it necessary
so as to maintain his high qualifications and skills, and so be able to continue selling his services to
others, including an employer. The deduction in Swingle was refused because the taxpayer was a
chemist, and the professional status of a chemist is not one recognized by statute. In Lemieux, 1982,
the taxpayer claimed deductions for dues he paid to the Association des médecins de langue
française du Canada, Association des médecins du Québec, and the Canadian Medical Protection
Association. All three deductions were refused. The first two were not required to preserve
Lemieux’s status as a resident physician, while the third did not qualify as professional membership
dues even though they might well be “essential” to the practice.
At times, the employment contract may oblige an employee to provide an office, supplies or
an assistant. Subparagraphs 8(1)(i)(ii) and (iii) permit the deduction of such expenses. In Watts,
1961, the taxpayer attempted to deduct the expenses of a housekeeper on the ground that she was an
assistant. The court disagreed, saying that the housekeeper did not assist the taxpayer in performing
her employment duties.16
INCOME FROM BUSINESS OR PROPERTY
Section 9 provides that “a taxpayer’s income for a taxation year from a business or property is the
taxpayer’s profit from that business or property for the year.” Profit is interpreted by courts as the
difference between total receipts and the costs and expenses necessary to produce such receipts.
Except where inconsistent with the law, the determination of profit is based on “well-accepted
principles of business practice” and “generally accepted accounting principles.” The ITA specifically
requires that certain items be included in computing income from business or property, such as:
 12(1)(a): Amounts received for goods and services to be rendered in the future
 …(b): Amount receivable for property sold or services rendered in the course of business
 …(c): interest
 …(d): amounts deducted in a preceding year as a reserve for doubtful debts
 …(g): amounts received based on production or use of property
 …(j) or (k): dividends
 …(x): inducement or assistance payments
For the most part, income from a business and income from property are subject to the same
treatment (see sections 9, 18, and 20). There are some differences however.17
16
17
For more detail on possible deductions by employees, see handbook p. 306-307
More on 12(1) inclusions and the business/property differences at handbook p. 309-310
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Income from a business
It is important to distinguish business activities from purely personal activities because when they
yield income, it will be excluded from computation if it is from purely personal activities, but not if it
comes from business; and in case of loss, only losses from business activities will be deductible. So
what constitutes a business? Subsection 248(1) defines a “business” to include “a profession, calling,
trade, manufacture or undertaking of any kind whatever and… an adventure or concern in the nature
of trade but include an office or employment.” This definition is not exhaustive and is supplemented
by a vast body of case law. In general, case law has established that a business is an organized activity
that is carried on for the purpose of profit.
Organized activity
In Graham, 1925, the taxpayer made money out of a habit of betting on horses. The court said that
betting was an irrational agreement in that “there is no relevance at all between the event and the
acquisition of property.” The court admitted that a bookmaker carries a business—because he has a
system designed to make a profit based on the whole aggregate of odds; i.e., there is an organized
effort to secure a profit—but that the situation was different from the point of view of the man who
bets. The betting taxpayer in Graham was not nearly as organized as a bookmaker, even though he
would bet regularly. There is no tax on a habit or addiction. In Walker, 1951, the court said that “each
case must depend on its own particular facts, the important feature being whether or not there was
an intention on the bettor’s part to make a profit, and not as a form of amusement or hobby.” In that
case, the taxpayer owned some horses, had the benefit of inside information about the probable
outcomes of the races, and he systematically attended all of them. The court said that he was in
business. But things can change through the years: in Morden, 1961, the court said of the taxpayer
that his gambling activities up to the year 1948 were so extensively organized and occupied so much
of his time and attention that it could be considered a business, but that since then his gambling
activities were only occasional and amounted to nothing more than indulging in a hobby, and his net
income therefrom was thus no longer taxable. In Luprypa, 1997, the court found that the taxpayer’s
business was betting on pool because he worked to minimize his risk (by practicing a lot and only
against drunk opponents) and because it was his primary source of income. In Epel, 2003, regular
poker winnings by the taxpayer were found to not be business income, as they were attributed to a
run of luck without a significant element of risk management. In Leblanc, 2007, the taxpayers made
massive bets on sports parlay games. Expert evidence on the statistical nature of the bets and the fact
that system effectively maximized risk led the court to conclude that it did not constitute a business.
It seems that, in that case, it did not matter whether the taxpayers’ intention was to make a profit and
that they simply had poor business judgment (see Stewart, below).
The pursuit of profit
In Moldowan, 1977, it was held that in order to have a “source of income” the taxpayer must have a a
reasonable expectation of profit (REOP), which is a objective determination to be made from all of
the facts, including the profit and loss experience in past years, the taxpayer’s training, the taxpayer’s
intended course of action, and the capability of the venture as capitalized to show a profit after
charging capital cost allowance. In Landry, 1995, the taxpayer was a 71-year-old who resumed
practicing law after 23 years away from the profession. He did so without adjusting his methods to
compensate for the realities of modern legal practice and suffered a loss. The court held that he was
conducting his practice so inefficiently that was no reasonable expectation of profit. The court’s
decision was based on an assessment of the taxpayer’s business judgment, not on any finding that he
was practicing as a hobby or otherwise for enjoyment. Then, in Stewart, 2002, the court introduced
the pursuit of profit test, saying that where the nature of an activity is clearly commercial, there is no
need to analyze the business decisions, and that, although in order for an activity to be classified as
commercial in nature the taxpayer must have the subjective intention to profit, this determination
should be made by looking at objective standards of businesslike behavior. The REOP is a factor to be
considered at this stage, but not the only factor, nor is it conclusive: the overall assessment to be
made is whether or not the taxpayer is carrying on the activity in a commercial manner. This
assessment should not be used to second-guess the business judgment of the taxpayer because it is
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the commercial nature of the taxpayer’s activity that must be evaluated, not his or her business
acumen. The court suggested the following two-step analysis:
1. Is the activity of the taxpayer predominantly undertaken in pursuit of profit (and is there
evidence to support that intention), or is it a personal endeavor?
2. If it is not a personal endeavor, is the source of income a business or property?
Business income is generally distinguished from property on the basis that a business requires an
additional level of taxpayer activity.
In that case, the taxpayer was a real estate investor who acquired condos from which he
earned rental income. The taxpayer claimed losses as a result of significant interest expenses on
money borrowed to acquire the units (his projections is that it would take ten years before would
start making profit). The government disallowed the deductions saying that Stewart had no REOP.
The court noted that the existence of financing is an element that points to the commerciality of a
venture, and that losses do not mean that no business (or property) source exists. Deductibility of
expenses is a separate question from whether a business exists. The court found that there was no
personal element to the taxpayer’s property rental activities, and that they constituted a source of
income. Finally, the court found that the taxpayer expected to profit from the sale of the condos and
that, while mere acquisition of property in anticipation of an eventual gain does not provide a source
of income for the purposes of section 9, it may be a factor in assessing the commerciality of the
taxpayer’s overall course of conduct.
A tax motivation does not affect the validity of transactions for tax purposes, and, absent a
sham or window dressing or similar vitiating circumstances, courts should not be concerned with the
sufficiency of the income expected or received (Walls, 2002).18
In Harrison, 2007, the government disallowed the deduction of business losses incurred in
the writing, publishing, and promoting of an obscure book, which the taxpayer described as a
mathematical biblical analysis. The court sided with the government. Applying the principles set out
in Stewart, the court concluded that (a) there was a personal element involved, and (b) in light of the
sales record and losses for the book, the taxpayer was unable to show that any commercial activity
was being carried out by him using objective standards of business-like behavior.
Adventure or concern in the nature of trade
Subsection 9(1) applies even if the taxpayer did not conduct a “business” in what might be the usual
sense of the word. If the taxpayer enters into an isolated transaction, and the transaction is
speculative and intended to yield a profit, the profit will be taxable as business income. This concept
is the borderline between income from a business and a capital gain. In short, when a taxpayer is in
the business of buying and selling property, the profit is clearly income from a business. When a
taxpayer buys property for investment purposes and eventually sells the property for a gain, the gain
is generally a capital gain. Capital gains are treated more favorably than business income because
only half of it is taxable. However, business losses are fully deductible while only one half of capital
losses are deductible and only against capital gains. Therefore, when the transaction is profitable,
taxpayers prefer to characterize it as a capital gain, and when it is unprofitable, as an adventure or
concern in the nature of trade (more on this in the section on capital gains and losses).
Income from property
A number of assets falling within the definition of property, such as building and machinery, will also
be used in the course of a taxpayers business. If income is derived principally from the ownership of
property, the income is generally considered to be income from property. On the other hand, if the
earning of the income involves a significant amount of activity, the income, is often income from a
business. For example, interest is clearly business income to a financial institution, but income from
property to an individual with a savings account. Dividends constitute income from property,
generally. Rental income is more difficult to categorize: in Walsh, 1965, the court said that the
question is whether the extent and nature of the services provided to tenants gives the rentals
received a trading character as distinct from mere income receipts from property. The landlord
18
For the facts of Walls, analogous to Stewart, and the facts of Ludco, see handbook p. 324-325
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taxpayers provided heat, some furniture, janitorial services, snow removal, etc. The court said such
services were normally provided by landlords and so insufficient to convert them from landlords into
businessmen. Services that could do that could be the provision of breakfast, maid, linen, laundry, etc.
Finally, rental property and other types of income earned by a corporation pursuant to the objects of
its incorporation are generally presumed to be income from a business (Burri, 1985).
Concept of property
Section 12 expressly brings into income certain items that are typically derived from a property
source. Subsection 248(1) defines “property” widely to mean property of any kind whatever,
whether real, personal, corporeal or incorporeal. The definition specifically includes:
1. A right of any kind, a share or a chose in action
2. Money, unless contrary intention is evident
3. A timber resource property
4. The work in progress of a business that is a profession
Generally, something of value is property for tax purposes. In Fasken, 1948, a contingent right to
receive income from a trust was considered property. However, in No. 481, 1957, it was noted the
benefit obtained by the covenantee under a covenant not to compete could not be property since it
had no character of ownership. Indeed, income from property is generally income derived from the
ownership of property.
Income from property is the value derived by the owner of a property from allowing another
person to use the property. The economic value derived by the owner from the use of his or her own
property—which is non-cash and arises outside the market place—is generally considered to be
imputed income and not taxable under the ITA. 19
Income from property vs. capital gains
Income from property and capital gains are two separate source of income for purposes of section 3.
The former is included in income under paragraph 3(a) and the latter under paragraph 3(b). To be
clear, subsection 9(3) expressly provides that income from a property does not include any capital
gain from the disposition of that property. Income from property, unlike capital gains, is fully taxable.
The issue of distinguishing between income from property and capital gain often arises in cases
where a capital property is sold and the sale price is paid in installments or the amount paid is
dependent on the use or production of the property. For anti-avoidance, subsection 16(1) treats
certain deferred payments as including a disguised loan, giving rise to interest income, while
paragraph 12(1)(g) treats payments that are based on the use of production of the property sold as
rent or royalties.
Interest income
Under paragraph 12(1)(c) of the ITA, any amount received or receivable “as, on account of or in lieu
of payment of, or in satisfaction of, interest” in included in the taxpayer’s income. The act does not
contain a definition of “interest,” but it is generally accepted in case law to compensation for the use
of money belonging to another person. It must be referable to a principal amount and must either
accrue daily or be allocable on a day-to-day basis. The amount of interest is determined by the
interest rate and the principal amount of a debt obligation. Late payments charges have been
considered to be interest.20
Where a taxpayer receives a single payment that includes both the repayment of capital and
interest, the payment is referred to as a blended payment. Subsection 16(1) requires that the
interest component be segregated and included in the taxpayer’s income. Blended payments may be
found in the following situations: original issue discounts, mortgage payments, and deferred
For policy concerns surrounding imputed income, see handbook p. 331-332
For more detail on discounts, bonuses, participating payments, income bonds, and indexed amounts,
see handbook p. 333-335
19
20
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payments.21 In Groulx, 1967, the taxpayer decided to forgo interest in order to sell his property
above the fair market value. The contract of sale included a payment of $85,000 paid immediately,
and a balance of $310,000 to be paid in annual installments. The court found that the balance amount
was a blended payment in an attempt to “capitalize interest.” In Rodmon, 1975, the court put it
simply: “if the price paid is in excess of fait market value, the excess is deemed interest; if the price
reflect the fair market value then there is no element of interest in the payment.” 22
There are special rules that apply to interest on personal injury damages awards or out-ofcourt settlements, but it is typically not considered income from a source.23
Paragraph 12(1)(c) requires interest to be included in income when it is received or
receivable, depending upon the method regularly followed by the taxpayer in computing his profit.
To the extent that interest has not been included as received or receivable by the taxpayer, 12(3) and
(4) require inclusion on an accrual basis. Subsection 12(3) requires corporations, partnerships and
certain trusts to include in income for a taxation year all interest accrued on a debt obligation during
the year (interest accrues on a daily basis). Subsection 12(4) requires an individual who holds a debt
obligation to include in his or her income for a taxation year all interest accrued to the anniversary
date (which includes the day the taxpayer disposes of the obligation—subsection 12(11)) of the debt
obligation occurring in the year.
The timing rules for interest income in paragraph 12(1)(c) and subsections 12(3) and (4)
realize an appropriate result where a debt obligation is held by only one taxpayer, but problems arise
where an obligation with accrued interest is transferred and the interest becomes payable after the
transfer. Subsection 20(14) provides that, in these circumstances, where the transferee of a debt
instrument has become entitled to interest that has accrued on the instrument for a time prior to the
transfer but is not payable until after the transfer, the accrued interest will be included as interest in
the income of the transferor for the year of the transfer, to the extent that it is not otherwise
included. The same amount may be deducted from the transferee’s income under subsection 20(14).
Rent and royalties
Paragraph 12(1)(g) provides that “any amount received by the taxpayer in the year that was
dependent on the use of or production from property whether or not that amount was an installment
of the sale price of the property” must be included in income. This provision generally applies to the
sale of property where the sale price is dependent on the production or use of the property. The
purpose of this provision is to prevent taxpayers from converting what would otherwise be fully
taxable rent or royalty income into capital gains. A rent is typically a fixed payment, usually periodic,
for the use of property for a given period of time, after which the right to the property expires. Rents
are generally paid in respect of the use of tangible personal property or real property. The term
royalty applies to the same concept for intangible property (there are also mineral royalties). Courts
have interpreted the notion of “use” broadly: a property is used by a person where the owner allows
him to take possession or make use of it. Royalties and rents need to be distinguished from sales
profit. Broadly, if all the legal rights in a property are transferred, the transaction constitutes a sale,
giving rise to sales profits; if less than all the rights are transferred, the transaction is a lease or
license and the payments are rents or royalties. Payments for computer software may be
characterized as royalties or purchase prices. Fees paid for acquiring a copy of custom software are
treated as royalties while fees paid for the right to use shrink-wrap software are treated as sale
proceeds rather than license fees or royalties. 24
For more information on blended payments, see handbook p. 335
For more information on the facts that a court looks at to determine whether a single payment
constitutes a blended payment subject to subsection 16(1), see handbook p. 336-338
23 See handbook p. 339
24 More on royalties at handbook p. 341-343
21
22
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Dividends
Special rules apply to dividends, which are sums paid on the shares of a corporation that represents
return on equity investment in a corporation. For more information about taxation of dividends, see
p. 344-345 of the handbook.
Deductions
Subsection 9(1) contains the primary rule for deductions. It defines a taxpayer’s income from a
business or property as the “profit therefrom for the year.” The term “profit” is not defined in the Act,
but the ordinary meaning of the term implies a net concept, and it is generally determined according
the accounting or commercial principles unless those are overridden by a provision in the ITA or
case law. Other provisions of the ITA disallow or allow various deductions from business or property
income. Key provisions include:
 Section 18, which specifically limits a deduction for certain expenses, such as expenses that
are not incurred for purposes of earning business or property income (18(1)(a)), capital
expenditures (18(1)(b)), and personal or living expenses (18(1)(h)).
 Section 20, which overrides section 18 and specifically allows a deduction of capital cost
allowance (20(1)(a)), interest (20(1)(c)), and other amounts. Section imposes limits on
these deductibility, and to the extent that they are not met, section 18 applies to prohibit the
deduction of the particular expenses.
 Section 67, which denies a deduction of expenses that are otherwise deductible to the
extent that the amount of the expense is unreasonable.
An expenditure properly deducted under accounting principles will be deductible for tax purposes
unless prohibited by some provision of the Act. Conversely, an amount not deductible pursuant to
accounting principles will not be deductible for tax purposes unless the Act provides a specific
deduction (see Daley, 1950, Canderel, 1998).
Business purpose test
It’s not always easy to determine if a payment was laid out for the purpose of earning income. In
Imperial, 1947, the taxpayer wanted the amount it had been obliged to pay in settlement of damage
claims arising out of a collision of one of its boats at sea. The court found that ”negligence on the part
of the [taxpayer’s] servants in the operation of its vessel, with its consequential liability to pay
damages for a collision resulting therefrom, was a normal and ordinary risk of the marine operations
part of the [taxpayer’s] business and really incidental to it.” Therefore, they are expenses “wholly,
exclusively and necessarily laid out as part of the process of earning income from such operations,”
and must be deducted as part of the cost thereof in order that the amount of profits may be
computed. Finally, the court said that “an item of expenditure may properly be deductible even if it is
not productive of any income at all and even if it results in a loss.” In Royal Trust, 1957, the court
confirmed that expenditure, to be deductible, must be directly related to the earning of income. The
deduction of the expenses in Royal Trust—admission and annual club fees paid by the employer so
its employees could attend social clubs and promote the employer’s services—is now prohibited by
paragraph 18(1)(l). Nevertheless, the case remains important for its statement that if an outlay or
expense is made or incurred by a taxpayer in accordance with the principles of commercial trading or
accepted business practice and it is made or incurred for the purpose of gaining or producing income
from business, then its amount is deductible for income tax purposes (unless, of course, specifically
denied by the ITA). The factors that led the court find that the expense met the business purpose test
were: (1) the policy was considered and tailored to the needs of the business, (2) it endured for
several years, (3) it was the practice of Royal Trust’s competitors, (4) it generated real benefits for
the company, and (5) it was a way of gathering business. The court equated this expense to a
promotional expense.
Personal and living expenses
These are generally not deductible in computing income from a business or property. They are
prohibited by the general requirements in subsection 9(1) and paragraph 18(1)(a). In addition,
paragraph 18(1)(h) specifically denies deduction, with an exception for expenditure incurred by
taxpayers while away from home in the course of carrying on business. Subsection 248(1) contains a
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non-exhaustive list of expenses that are included in the definition of “personal and living expenses.”
Section 63 now authorizes deduction for childcare expenses and section 62 allows for certain
moving expenses; however these deductions are limited by reference to income generated by the
taxpayer’s move or by the freedom from domestic duties (see the section on subsection e
deductions).
In Benton, 1952, an old, single and semi-invalid farmer hired a housekeeper to assist him
with household maintenance, which freed him to work on the farm. Deduction for the housekeeper’s
wages was disallowed as she was “primarily a housekeeper engaged in the usual domestic duties
performable on a farm and that her contribution to the income-earning work of the farm was
necessarily of a secondary nature, however helpful it may have been to the [taxpayer].” In Leduc,
2005, the taxpayer spent $140 000 in legal fees to defend himself against charges of sexual
misconduct. Several of his clients, who happened to be priests, were similarly charged. Leduc argued
that he had to hire a lawyer to protect his professional status (following the charges, Leduc’s
business improved and he earned more income). Leduc was not allowed to deduct the cost of his
legal expenses under. The court said that, while Leduc was motivated to defend himself for two
reasons—to protect his liberty and to protect his professional standing—the fact that there is a
personal motivation is not sufficient to negate the deduction. Therefore, it looked to the nature of the
expense to see if the expense was an ordinarily incurred expense really incidental to the taxpayer’s
business:
 Is the expense ordinarily allowed by accountants?
 Is it normally incurred by others in the same business?
 Would it have been incurred had the taxpayer not been engaged in business?
 Would the need have existed apart from the business?
The court found that lawyers would not normally have incurred the expense at issue, and that Leduc
would have had to defend himself whether or not he practised law, so deduction under 18(1)(h) was
not acceptable. Besides, the taxpayer’s earning capacity was not in jeopardy at the time the legal
expenses were incurred. It was far from certain that following a conviction Leduc would have lost his
license to practise law, and because this eventuality was considered purely hypothetical and
speculative by the court, it was judged to remote to justify deduction under 18(1)(a). Had Leduc
been charged with professional negligence, he might have been able to deduct the costs.25
Childcare expenses
In Symes, 1994, a lawyer claimed salary paid to her childcare provider as business income
deduction, arguing that current social and economic realities of women in the work force made child
care expenses a legitimate business expense under paragraphs 18(1)(a) and (h). The court noted
several things: first, that it was clear on the fact that the appellant would not have incurred childcare
expenses except for her business—however, the need that is met by childcare expenses exists
regardless of the business activity. Second, while the decision to have children is not purely a
personal, consumption choice—indeed, the whole of society benefits from reproduction—there was
no evidence to suggest that accountants consider childcare expenses as business expenses. Third, while
expenses incurred in order to make the taxpayer “available” to the business are traditionally seen as
non-deductible personal expenses, it might be correct in view of changing social structure to demand
a reconceptualization. The court nonetheless disallowed the deductions because of section 63, but
that is discussed further below (see section on subdivision e deductions). 26
Food and beverages
We all need food and beverages to survive, regardless of our business. In Scott, 1998, the
taxpayer was a “foot and transit” courier, and this type of employment required him to consume
what essentially amounted to an extra meal per day. He sought to deduct only a reasonable amount
for the expenses incurred for food and beverages over and above what the average individual would
need to consume on a daily basis. The court said that the three following questions are helpful in
25
26
For policy on personal and living expenses, see handbook p. 365-366
For policy on personal and living expenses, see handbook p. 372
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determining whether an expense qualifies as a reasonable business expense or whether it is a
personal and living expense:
 What is the need that the expense meets?
 Would the need exist apart from the business?
 Is the need intrinsic to the business?
The court went on to note that the Act allows businesspersons to deduct up to 50% of their food and
beverage expenditures for meals of a business nature (section 67.1). The deductions were allowed
but the court warned that “only where there is a corresponding business deduction allowed for fuel in
the form of gasoline for the same type of business will a deduction for the extra food and water a
human needs to consume as its fuel be allowed.”
Commuting expenses
Expenses incurred by taxpayers to travel between home and the work location are generally
considered to be personal or living expenses. In effect, the choice where to live is considered a
personal consumption decision. On the other hand, travel expenses are a routine cost of doing
business and will commonly be unquestioned as deductions for tax purposes, even though there is
sometimes a personal element. In Cumming, 1967, an anaesthetist earns income from business at a
hospital. He claimed the deduction of travel expenses from home to hospital and a deduction of
capital cost allowances. The court allowed it. The court found that his home office was his only office
space—the space was out of bounds to his children, he spent about 12 hours a week there, and his
wife also spent 12 hours a week doing administrative work there. The court said that although he
administers services at the hospital, Cumming’s base of operations was his home office. He would
return there when he was not busy at the hospital. Travel between these points was required. It was
not an issue of personal preference. He simply did not have an office at the hospital where he could
do his work. Where a professional has to travel to and from two work locations, expenses should be
partially deductible—partially because where a person lives relative to work is a personal
consumption choice. In this case, the court gave him 25% of his operating costs, since work travel
constituted about 25% of his mileage. On the capital cost allowance issue, the court used a different
measure (50%) based not only on the use of the car, but also on obsolescence (it was decreasing in
value while parked at the hospital), which is as much a factor of time as use.27
In Hogg, 2002, the taxpayer argued that security concerns converted the otherwise personal
character of expense incurred traveling to and from work into deductible expenses. An agent in the
administration of justice, he feared assaults while commuting to work. While sympathetic to the
taxpayer’s concerns, the court denied the deductions; the matter of personal security, though a
function of his work, was not sufficient to render the expense deductible.
Home Office Expenses
Subsection 18(12) was introduced to deal with home office expenses. This provision prohibits the
deduction by an individual of home office expenses, unless the home office:
(1) Is the taxpayer’s “principal place of business,” or
(2) Is used exclusively for business and on a regular and continuous basis for meeting clients,
customers or patients.
Qualified expenses can only be deducted to the extent of the taxpayer’s income for the business for
the year—a loss cannot be created or increased. However, unused losses can be carried forward
indefinitely by virtue of paragraph 18(12)(c). The reference to “expenses otherwise deductible
under the Act” suggests that the business purpose test of subsection 9(1) and paragraph 18(1)(a)
must be met, and provisions such as paragraph 18(1)(h) and section 67 must be complied with. The
most common method to fix the amount deductible is to determine the amount of space occupied by
the office compared to the total usual area of the home. A proportionate amount of the expenses of
the home—mortgage interest, insurance, property taxes, utilities, etc.—are then taken as a business
deduction. If the taxpayer were renting a home, a percentage of rent paid would be included as well.
27
For a case that was distinguished from Cumming, see handbook p. 382
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Entertainment and business meals
Subsection 67.1(1) limits the deduction of food and entertainment expenses to 50% of the lesser of
the actual cost or a reasonable amount. The prevailing rule is that if the principal purpose of the
entertainment is business, the expenses are deductible. In those cases where part of the expense is
disallowed it is usually because the taxpayer cannot substantiate the full amount claimed. 28
Education Expenses
Education expenses have been characterized as non-deductible personal expenses. However, the
courts have distinguished between the cost of a post-graduate course and the normal refresher
courses taken by professionals, and amounts paid for the latter may be treated as deductible
expenses. Note that section 118.5 provides a tax credit for tuition fees paid for obtaining postsecondary education, and section 118.62 does the same with respect of interest on student loans.
Public policy
Sometimes the courts will prohibit the deduction of certain expenses if it would result in a frustration
of public policy. The concept of income reflected in section 3 does not distinguish between income
derived from legitimate activities and income from illegal business activities.
Illegal businesses
In Eldridge, 1964, the taxpayer ran a brothel. She was taxed on the income for her illegal business
activities. She deducted her expenses including: rent, telephone inspection, payment for assistance to
prostitutes, protection fees, and liquor payment fees (bribes to civil administrators). She paid $1,300
in cheques, $18,900 in cash. She also had to pay bail bonds to get her employees out of jail. The court
allowed Eldridge to deduct the rent paid to operate the premises where her call girls would meet
their clients. The court also allowed the bail bonds for her employees, but not for herself: her
business had already been terminated when she was jailed, so it was purely personal, but getting the
employees out was part of an obligation incurred while she was in business. The expenses that could
not be proven could not be deductible: these include the “telephone inspection fee” and the “protection
fees.” The expenses for buying up the “defamatory” newspapers were refused, since the court found
that circulation of the newspaper would probably have been good for business, so buying it up could
not be an expense made to earn income. Here, the court substituted its own business judgment to
that of the taxpayer.
Fines and penalties
It used to be possible to deduct some fines and penalties, but now section 67.6, applicable to fines
imposed after March 22, 2004, denies the deduction of fines or penalties.
Interest
One tax shelter plan involves the acquisition of capital property, deducting the interest expenses and
then benefiting from the capital gain (see e.g. Stewart). A taxpayer can deduct interest only when the
taxpayer has a legal obligation to pay within the taxation year (section 20(1)(c)). The interest is
deductible when related to the acquisition of capital property used for earning income. Personal use
borrowing does not produce deductible interest. If the source of the income disappears, the interest
on the loan is no longer deductible, but the ability to deduct interest on a loan is not lost simply
because the taxpayer sells the income-producing property acquired with the loaned funds when the
taxpayer reinvests the proceeds in an eligible use property, and as long as the replacement property
can be traced to the entire amount of the loan, the interest on the loan remains fully deductible
(Tennant, 1996). Section 20.1 says that so long as the taxpayer maintains the source, or traceable
proceeds, the taxpayer can continue to deduct the interest expenses. Also, if the taxpayer uses the
proceeds of disposition to repay the loan, the taxpayer can continue to deduct the interest
28
For policy on entertainment expenses, see handbook p. 385
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expenses.29 Subsection 20(3) stipulates that interest on money borrowed to repay an existing load
shall be deemed to have been used for the purpose for which the previous borrowings were used.
A major area of litigation relates to the condition in 20(1)(c)(i) that the borrowed money be
used for the purpose of earning income from business or property. This condition does not require
that income actually be generated, but an intention and a demonstrable use of the funds for this
purpose must be established. In Bronfman, 1987, a trust borrowed $2.3 million from the bank, so as
not to sell off income-earning stocks. It paid the money to its beneficiaries. The trustees argued that
they should be able to deduct the interest expenses because they preserved the income-producing
assets in the trust. The court disallowed the interest deduction because the current and direct use of
the money was not eligible use—the proceeds of the burrowed funds was traceable to the
beneficiaries; it had not been retained by the trust and applied for purposes of earning income. The
court made a variety of relevant observations:
 The taxpayer must satisfy the court that his or her bona fide purpose in using the funds was
to earn income.
 The courts must deal with what the taxpayer actually did, and not what he might have done.
 What is aimed at is an employment of the burrowed funds immediately within the company’s
business and not one that effects its purpose in an indirect and remote manner
 What is relevant is the taxpayer’s purpose in using the borrowed money in a particular
manner […] It is the current use that is relevant: a taxpayer cannot continue to deduct
interest payments merely because the original use of borrowed money was to purchase
income-earning assets, after he or she has sold those assets and put the proceeds of sale to
an ineligible use […] Conversely, a taxpayer who uses or intends to use borrowed money for
an ineligible purpose but later uses the funds to earn non-exempt income from a business or
property ought not to be deprived of the deduction for the current, eligible use
 The burrowed funds must still be in the hands of the taxpayer, as traced through the
proceeds of disposition of the preceding ineligible use, if the taxpayer is to claim the
deduction on the basis of a current eligible use.
 The fact that the taxpayer continues to pay interest does not inevitably lead to the
conclusion that the borrowed money is still being used by the taxpayer, let alone being used
for an income-earning purpose.
In Trans-Prairie, the company raised money by selling preferred shares. The taxpayer decided to recapitalize its debt by taking out debentures to repay its shareholders. Transprairie pays interest on
the debentures. The taxpayer did not acquire a new income-producing asset with the debenture
money. It simply repaid its shareholders. The court in that case allowed the deduction of interest,
because Transprairie recapitalized its business. 30 Bronfman is often said to have overruled TransPrairie, although the court in Bronfman said it didn’t. In Ludco, 2001, the SCC established that the
requisite test to determine purpose for interest deductibility under subparagraph 20(1)(c)(i) is
whether the taxpayer had a REOP at the time the investment was made. In Attaie, 1990, the taxpayer
moved from Iran to Canada and borrowed funds to purchase a house. Initially, the house was rented
out and the rental income declared on his tax return. He deducted expenses related to the property
including the interest paid pursuant to the mortgage. The taxpayer subsequently moved into the
property, occupying it as his residence. Shortly thereafter, he received $200,000 from Iran. Rather
than use this money to pay off the mortgage, he chose to invest it in terms deposits because the rate
of interest on the investments was significantly higher than the interest payable under the mortgage.
On his income tax returns for the years in which he occupied the house, the taxpayer sough to offset
the interest payable under the mortgage against the interest generated by the term deposits. In
denying the deduction of mortgage interest, the court looked to the direct use of the borrowed funds:
For example, if a taxpayer buys shares for $100 using a loan and sells them at a loss for $50, the
taxpayer can continue to deduct interest if (1) he repays the $50 loan or (2) acquires other incomegenerating property with the remaining $50.
30Trans-Prairie used the debenture money to refinance its business. The Bronfman trust used the
money to pay its beneficiaries. Trans-prairie, therefore, can be distinguished on its facts.
29
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the money was borrowed to finance what was now a personal residence, an ineligible use. Therefore,
the taxpayer could not deduct the mortgage interest. In Singleton, 2002, the taxpayer was a lawyer
and his capital account at the law firm was of $300,000 (from original capital contributions not made
with borrowed funds). Singleton used the money of equity in the firm to purchase a house, and then
he borrowed from a bank that same amount to refinance his partnership capital account. He
deducted the interest pursuant to 20(1)(c)(i). The said that this provision contained four elements:
(1) The amount must be paid in the year or be payable in the year in which it is sought to be
deducted
(2) The amount must be paid pursuant to a legal obligation to pay interest on borrowed money
(3) The borrowed money must be used for the purpose of earning non-exempt income from a
business or property
(4) The amount must be reasonable, as assessed by reference to the first three requirements
The Singleton case dealt only with the third element. The focus of the inquiry, reminded the court, is
not on the purpose of the borrowing per se, but is on the taxpayer’s purpose in using the money: if a
direct link can be drawn between the borrowed money and an eligible use, this third element is
satisfied. The court also emphasized that taxpayers are entitled to structure their transactions in a
manner that reduces taxes, and that the court must simply apply the wording of 20(1)(c)(i) rather
than search for the economic realities of the transactions. In this case, even though it can be said that
he would not have needed to borrow if he hadn’t bought a house, it is nonetheless clear that the
taxpayer did use the borrowed funds to refinance his capital account—that was the direct use to
which the borrowed money was put. Why the money was burrowed is irrelevant and of no impact on
the application of 20(1)(c)(i). It is also irrelevant that by his own admission the taxpayer structured
the transaction for tax purposes.31 The court thus allowed the deduction of interest. In Lipson, 2009,
the taxpayer, Earl, sold shares of a family corporation to his wife, who paid for the shares using funds
borrowed from a bank. The taxpayer and his wife also entered into an agreement to purchase a new
home, which Earl purchased with the proceeds from the shares sold. The couple subsequently
obtained a mortgage from a bank, the funds from which were used to repay the share loan. The
mortgage interest was deducted from the dividends on the shares attributed to the taxpayer under s.
74.1(1) of the Act. The Minister assessed the taxpayers under the general anti-avoidance rule
(GAAR), disallowing the deductions on the basis that the series of transactions constituted a misuse
and abuse of the interest deductibility provisions, the election provision of s. 73(1), and the
attribution provisions of s. 74.1(1) the Act. Neither the GAAR nor s. 74.1 of the ITA was at issue in
Singleton, so it was distinguishable. In brief, the GAAR denies a tax benefit where three criteria are
met:
(1) The benefit arises from a transaction (ss. 245(1) and 245(2));
(2) The transaction is an avoidance transaction as defined in s. 245(3);
(3) The transaction results in an abuse and misuse within the meaning of s. 245(4).
The taxpayer bears the burden of proving that the first two of these criteria are not met, while the
burden is on the Minister to prove, on the balance of probabilities, that the avoidance transaction
results in abuse and misuse within the meaning of s. 245(4). The focus of the GAAR analysis must be
on the individual benefits rather than the overall result. In this case, there were two tax benefits in
the context of the GAAR analysis: the interest deduction available by virtue of ss. 20(1)(c) and 20(3)
of the Act, and the allocation of the deduction to Earl under the attribution rules. The court was
divided. The majority found that the fact that the wife financed the purchase of the shares with debt,
and Earl financed the purchase of the residence with equity, giving rise to the interest deduction, did
not constitute a misuse or abuse of ss. 20(1)(c) and 20(3). However, Earl's deduction of the mortgage
loan interest to reduce his tax payable on the net dividend income attributed to him, which would not
have been available without the transfer of the shares to his wife, constituted an abuse of the
attribution rules under s. 74.1(1) of the Act. Thus the Minister's subsequent disallowance of the
interest expense in computing the income or loss attributed to the taxpayer, and the allocation of the
interest deduction back to the wife, was a reasonable outcome by virtue of applying the GAAR. A
dissent said the series of transactions at issue was a tax avoidance scheme that was not abusive
31
For more detail and sample problems on interest deductions, see handbook p. 420
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under the GAAR. The taxpayer was entitled to transfer the shares to his wife, and to benefit from the
application of the attribution rules under the Act. Another dissent said there were no abuse of ss.
20(1)(c) and 20(3). A taxpayer is entitled to arrange his or her affairs in order to finance personal
assets out of equity, and income earning assets out of debt. Since the main reasons for the transfer of
the shares to the wife was to reduce the dividend income on the shares, s. 74.5(11) was an antiavoidance rule that applied to preclude the use of the attribution rules. As a result, the Minister
should have relied on s. 74.5(11) in order to reassess the taxpayer in respect of his use of s. 74.1(1),
rather than invoking the GAAR, which did not apply.
Limitations on deductibility
Section 67 provides that no deduction shall be made in respect of an outlay or expense otherwise
deductible under the Act, except to the extent that the outlay or expense was reasonable in the
circumstances. Although it applies to both arms and non-arms length transactions, it is rarely
invoked in arms-length transactions because it is assumed the price was fairly agreed upon. Rather,
this section has served to curb a contrived reduction of income through the deduction of expenses
that are largely personal in nature, or where amounts have been diverted to persons who are not at
arm’s length. In Mulder, 1967, two brothers controlled a company, and one of the wives was paid a
salary of $13,000. The tax authorities contested the amount of and reduced the deductible salary to
$7,000. The court considered whether the salary was reasonable for the services that she renders (as
if she was not married and dealing at arm’s length). The court acknowledged that the wife was key to
the management of the company, and said it would have been reasonable for the company to charge
a salary to the wife of $8,500 as an item of expense. The court then made some observations. I am not
sure of their relevance for this course, but here they are:
 The husband caused his salary to be reduced to $13,000 (in comparison, his brother’s was
$20,000) and have his wife’s salary be the same amount. To permit him to do that would, in
effect, give him the right to juggle his income to attract a minimum of tax which would most
certainly be contrary to the spirit of the ITA
 It is not sound for a corporation to add something directly into the salary of one of its
officers for past services.
 If a corporate shareholder still has profits available after paying reasonable salaries, such
profits can be paid out to the shareholders as dividend.
In No. 511, 1958, a lumber business paid to advertise via sponsorship of a baseball team, and claimed
$22,500 in deductions, representing half of the business’ net income of $42,874. The court found that
there was an element of personal enjoyment to the expense, since the business owner really liked
baseball and didn’t want to see the in question team stop playing for lack of funding. The court then
said that, taking into account the size of the business, the expected patronage in the future, the form
of advertising, the locality where it was done, and the size of the population it reached, a reasonable
advertising expense would have been $5,000 and so allowed only part of the amount for deduction.
This is an example of section 67 applying in an arm’s length situation.
In Cohen, 1963, it was decided that a payment of $12,000 by the taxpayer to his wife as rent
for a dental office in their home was unreasonable. The taxpayer’s argument that accommodation in
the local Medical Arts Building would have equalled the claimed deductions was rejected, and the
amount of the deduction was reduced to $5,000. In Beauchemin, a plastic surgeon tried to deduct the
costs relating to an SUV and a Porsche as expenses needed for his business. The court allowed the
business expense but tuned down the amount relating to the Porsche because of its luxury element.
The restriction in section 67 can be said to displace the business judgment of the taxpayer. In Tonn,
1996, the court said that section 67 should be carefully applied so as to not discourage or penalize,
honest but erroneous business decisions because, after all, the tax system does not tax on the basis of
a taxpayer’s business acumen.
Section 67.2 limits the amount of interest expense deductible in respect of the acquisition of
a “passenger vehicle” as defined in 248(1), which may otherwise be deductible in computing income
from a business or, in certain circumstances an office or employment (see 8(1)(j)). The interest
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deductible is limited to an amount prescribed by regulation, currently at $250 per month. Section
67.3 limits the deductible costs of leasing a passenger vehicle, currently prescribed at $700/month. 32
COMPUTATION OF PROFIT AND TIMING PRINCIPLES
Taxpayers strongly prefer to pay their taxes later rather than sooner because they retain the use of
the money longer. Likewise, one would rather deduct expenses sooner than later. 33
Relevance of financing accounting
In Canderel, 1998, the court said that the “goal of the legal test of ‘profit’ should be to determine
which method of accounting best depicts the reality of the financial situation of the particular
taxpayer.” When no specific legal rule has been developed, either in the case law or under the Act, the
taxpayer will be free to calculate his or her income in accordance with well-accepted business
principles, and to adopt whichever of these is appropriate in the particular circumstances, is not
inconsistent with the law, and yields an accurate picture of his profit for the year. If this is
demonstrated, the onus shifts to the Minister to prove either that the figure does not constitute an
accurate picture of income or that some other method of computation would yield a more accurate
picture.34 In this case, Canderel was in the real estate business. They signed up tenants for buildings,
so that tenants would move in when buildings were complete. Canderel made payments to
prospective tenants, even though the tenants are not leasing the properties yet. In its accounting
statements, Canderel amortized the tenant inducement payments over the term of the lease;
however, it wished to deduct the TIPs right away as “incurred expenses.” The court pointed it out
that generally accepted business principles (which include GAAP) are not determinative; they are
interpretive aids. The motivation behind GAAP is to present a conservative picture of income and this
is not necessarily appropriate for tax purposes. GAAP is interested in a comparative picture, but
again, this is not relevant for computing income for tax purposes. The Court then discussed the
matching principle: the taxpayer should try and match the revenue with the expenses incurred to
earn that revenue, which will produce a true picture of income in a give year. The court noted that
there will sometimes be than one principle applicable to certain cases. In this case, there were 3 ways
to recognize payments: the taxpayer was entitled to treat the payments either as operating expenses,
fully chargeable to the results of operations in the year incurred, as capital expenditures to be added
to the cost of the building and depreciated, or as deferred expenses to be amortized over the life of the
relevant leases. The court found that immediate deduction is not inconsistent with the law. Nothing
in the act prohibited this deduction. It was also in accordance with generally accepted commercial
practice. Furthermore, the benefits obtained through the payments were not limited simply to the
leases: Canderel had to satisfy interim financing as an essential element to obtain long term
financing.35 Because the payments were referable to present and future benefits, the taxpayer met its
burden of proof; the matching principle could not apply to require that these expenses be spread out
over time. (see Tobias and Tower, CN19).
Tax accounting
See handbook p. 437 and 438 for the basic rules for taxation periods. For individuals, it is the
calendar year. Subsection 249.1(4) permits individuals who operate businesses and partnerships to
retain an off-calendar fiscal period. However, section 34.1 eliminates the deferral opportunity by
More on automobile expenses deductions, see handbook p. 426
For examples, see handbook p. 427
34 There is a very useful list of principles laid out at p. 434 in the handbook
35 To obtain financing, a builder must get leases in advance in order to show the financer that the
building will be a viable enterprise. This also prevents a gap in income following the completion of
the building. Furthermore, Canderel had to maintain its position in the market. The rentals,
themselves, were benefits.
32
33
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requiring the individual to include in income of a calendar year an estimate of the business income
for the period February 1 to December 31.
There are two basic methods of accounting: the cash method and the accrual method. Under
the cash method, all that is accounted for in the accounting period are revenues actually received by
the taxpayer and expenses actually paid by the taxpayer. Income from office or employment is
generally computed on a cash basis. Payments received by a third person (such as an escrow agent)
on the taxpayer’s behalf are generally considered to be received by the taxpayer. Payments can be
made in cash, in kind or by setting off an existing obligation. Cheques are treated like cash. Under the
accrual method, income is recognized in the year in which it is earned, regardless of when payment is
actually received, and the deductions are claimed in the year in which they are incurred, regardless of
when they are paid. The accrual method is used in computing income of corporation and most
businesses.36
Timing
But when is income earned and expenditure incurred? The Act does not say.
Recognition of revenue
Income from the sale of property and the provision of services are two of the most important types of
income from a business. The timing of recognition of these two types of income is governed by
paragraph 12(1)(b) of the ITA. Pursuant to his provision, revenues from the sale of goods or services
in the course of a business are included in computing profit when they become receivable. In Colford,
1960, the court said that it is not enough that the so-called recipient have a precarious right to
received the amount in question, but he must have a clearly legal, though not necessarily immediate,
right to receive it, and his right to it must be absolute and under no restriction, contractual or
otherwise, as to its disposition, use or enjoyment. In Colford, the taxpayer, a contractor, had 10% of his
fees held back and he would become entitled to them only upon acceptance of his work by the
architect. The court found that to be a binding condition precedent on the taxpayer which prevents
him from claiming the amount, which meant that the holdbacks were not receivable until the
architect issued his certificate, because at that point were the holdbacks were payable to Colford.
However, the court warned that it is the date of execution of the certification that governs, and not
the date on which Colford obtained knowledge of the existence of the certificate or the date on which
the amount falls due. In Benaby, 1967, the taxpayer’s year-end was April 30, 1954 (1954 taxation
year). Land belonging to him was expropriated in January 1954. In November 1954 (1955 taxation
year), an amount for compensation was determined. The court noted ascertainability of the amount is
a necessary requirement to declare income for a taxation year. This makes sense if a taxpayer was to
plug a number into the tax return. Since the amount was not known until the 1955 fiscal period, that
is when it should have been included. In West Kootenay, 1992, a power company had distributed
electricity, but they had not billed their customers yet by the end of the taxation period. The court
pointed out that electricity is considered to be property under the Sale of Goods Act, and a seller is
entitled to payment upon delivery of the property—a bill is not a precondition to payment. The
income for the delivery of the electricity was receivable although no yet due and sufficiently
ascertainable, and the company had an absolute right to receive payment once the electricity was
delivered. The matching principle required that the company included the income in the year in
which it earned it: the billing cycle could not alleviate a taxpayer’s burden to include amounts
receivable. In Maritime Telegraph, 1992, the court said while GAAP authorizes both the billing and
the “earned method,” the earned method is the method that provided a truer picture, and that the
purpose of paragraph 12(1)(b) was to ensure that income from a business is computed on the
accrual basis, not a cash basis, with certain specified exceptions. Hence section 12(1) operates so as
to expand section 9(1)’s ambit of inclusion. Here are in West Kootenay, the unbilled income was
quantifiable and therefore had to be included in income for the year.
36
For sample fact patterns, see handbook p. 439 and Summary 3 p. 56 for answers
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Summary by Pascal Archambault-Bouffard for Allard’s Fall 2010 Taxation course
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Recognition of expense
In general, the timing of “paid” and “payable” is related to the timing of “received” and “receivable.”
The time when an expense is incurred is when all the events occur that establish the taxpayer’s
liability to make the payment and the amount due can be determined with reasonable accuracy. In
Guay, 1971, holdbacks became payable only after the architect’s certificate was issued, which wasn’t
issued until the following taxation year. The issue was whether the holdbacks were deductible as
expenses in the earlier year. This case was a mirror image of Colford. The court said that the
holdbacks become payable only when the certificate is issued and the obligation to pay is no longer
contingent, but certain. Thus the holdbacks were not deductible as expenses until the issuance of the
architect’s certificate. Finally, until the architect has issued his certificate, it is impossible to
determine if the holdbacks will be paid in full or only in part, if at all—hence the amounts were not
ascertainable.
So, as a general rule, an expense is deductible in the year in which it is incurred, and
according to Guay, an expense is incurred in the year in which the taxpayer has a legal and
unconditional, though not necessarily immediate, obligation to pay the amount. It does not follow
that all expenses that relate to the income earning process are deductible in the year in which they
are incurred. Recall the discussion in Canderel of the matching principle…
In the recent decision of Collins, 2010, the Federal Court of Appeal clarified the meaning of
“an amount payable in respect of the year”—one of the requirements for interest deductibility under
paragraph 20(1)(c) of the Income Tax Act (the "Act"). Specifically, in order for interest to be
deductible under paragraph 20(1)(c) of the Act, there must be:
(i) an amount paid or payable in respect of the year
(ii) pursuant to a legal obligation to pay interest
(iii) on borrowed money used for the purpose of earning income from a business or property
According to the Federal Court of Appeal, "payable in respect of the year" does NOT mean "due in the
year," or "required to be paid in the year." Interest is considered "payable in respect of the year"
where it is properly accrued in the year, even though the full amount of interest was not required to
be paid in the year of accrual, but rather, was required to be paid in a subsequent year. Collins,
reversing an earlier decision by the Tax Court of Canada, represents a good win for the taxpayer.
Allard said that this case did not advance us much… the whole area of interest deductibility in respect
of timing remains quite uncertain… also, Allard disagrees and thinks the obligation to pay the interest
was conditional and uncertain.
Modifications
The general timing rules discussed above are subject to statutory exceptions. Here are some:
Advance payments for unearned income or prepaid income
Under 12(1)(a) such amounts must be included in the taxpayer’s income in the year in which they
are received, even though they have not been earned in that year because the taxpayer has not
obtained the absolute and unconditional right to retain the amount. Paragraph 20(1)(m) allows the
taxpayer to deduct a reasonable reserve, which as it turns out will often equal the full amount. As a
result, the unearned income is not truly included in computing income until earned.
Prepaid expenses
Subsection 18(9) prohibits deductions in computing income for a particular year in respect of
prepayments made in that year for certain items: (a) services to be rendered after the end of the
year; (b) interest, taxes, rent or royalties with respect to a period after the end of the year, (c)
insurance with respect to a period after the end of the year. 37
Reserves
Reserves essentially represent the possibility that the earned income may never be received, or that
an amount will probably have to be expended in the future but that relates to the revenues earned in
37
More on prepayments at handbook p. 454
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the year. For tax purposes, the general rule is that no deductions are permitted on account of
reserves or contingent liabilities: paragraph 18(1)(e). Amounts set aside in anticipation of future
events cannot generally be deducted in computing income because such amounts are too contingent
or uncertain. However, the ITA provides several exceptions to the general rule:
 Paragraph 20(1)(m) (see above)
 Paragraph 20(1)(n): deferred payments for property sold. A similar reserve is available
under paragraph 40(1)(a) for the sale of capital property. These reserves are designed to
apportion the profit or capital gain over the period during which the proceeds of sale are
receivable, although there are limitations (more on this in the section on the taxation of
capital gains and losses). The allowable reserve is: gross profit divided by gross selling price,
then multiplied by the amount due.
 Paragraph 20(1)(l): reserve for doubtful debts, which represents an attempt to reduce the
value of an account receivable to the amount likely to be realized. Paragraph 20(1)(p)
additionally permits a deduction for bad debts. For the rules on bad doubtful and bad debts,
see handbook p. 456-457.
Reserves taken in one year must normally be included in income in the next year (although another
reserve can claimed for that year). For example, let’s say you’ve received $10,000 in 2010, but will
only earn it in 2011. Let’s also say that in 2011 it cost you $9,000 to deliver the goods:
2010
12(1)(a)
Expenses
20(1)(m)
12(1)(e)
TOTAL
2011
10k
(9k)
(10k)
null
10k
1k
Capital cost allowances
Capital expenditure is deducted over several taxation years. The rational is that these expenses
provide a lasting benefit to the taxpayer’s business and only a portion of the expenditure can be
deducted each year during the useful life of the capital property.
Inventory
An attempt is made to match the costs to the year in which the inventory is sold.
Modified accrual for professionals: section 34 election
A professional generally must recognize income from services as it is earned, notwithstanding that
an account has not been sent. Income from services is earned as the services are performed, and not
necessarily when the contract is completed. Therefore, income from work-in-progress must be
recognized at the end of the fiscal period. Under subsection 10(5), work-in-progress of a professional
is considered part of inventory and as such, the expenses associated with it cannot be deducted until
it is completed. Subsection 10(4) provides that WIP must be valued at its realizable value. Section 34
permits certain listed professional (doctors, lawyers, accountants, dentists, vets and chiros) not to
include any amount on account of WIP in determining income for tax purposes. That means that, on
the revenue side, the value of the WIP need not be included in income until a bill is rendered, and on
the expenses side, expenses to generate WIP can be deducted when they are incurred. In Brock,
1991, the taxpayer was a lawyer. He sent out interim bills to his clients. He argued that since this was
work in progress, he could defer the income until the next taxation year. The court disagreed. The
bills were not framed as “statements” about WIP, they were collections from the clients, who were
given 10 days to pay. The court said that although section 34 of the Act allowed professionals to defer
work in progress until the work is complete, amounts are deemed receivable when they are invoiced
or should have been invoiced. Brock invoiced his clients, and therefore he had to include those
amounts in his income.
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Inventory
Inventory will not be considered in detail in this course. See handbook p. 461-476 and onward (or
other summaries) for the tax treatment of inventory.
Capital expenditure
Current expenses are fully deductible in the year incurred, but if it is a capital outlay, the we have to
see if it is subject to the capital cost allowance rules or the eligible capital property rules, both of
which allow deductions over a period of years. Before 1972, capital costs were not deductible. Today,
they are. If it is not a current expense, not subject to CCA or to eligible capital expenditure provisions,
then it is a “nothing” and no deduction is permitted.
Current expenses vs. capital outlays
In determining the proper tax treatment of an expense, the analysis first should determine whether
an expense is a current expenses or a capital expense.
Tangible assets
In British Insulated, 1926, the company invested a significant sum of money into a pension fund. The
company sought to deduct the expense as a current expense. The tax authorities contended it was a
capital outlay. Had the company started the fund years prior it would have been current expenses,
but as of now it was a start-up fund and the issue was whether of not that was a capital outlay. The
court said that it was. The expense in question was non-recurring. It brought about the existence of
the pension fund. The contribution formed the “nucleus” of the pension fund. Most importantly, the
benefit that the expense secured was an enduring one. In Denison, 1972, the taxpayer wanted to treat
the cost of extracting ore as a capital cost.38 It argued that the extraction process created
throughways or passageways, which was new capital. The passageways would provide an enduring
benefit to allow Denison’s employees to access ore. The court disagreed. The court said that we must
look at ordinary commercial principles to determine whether said expenses are current expenses or
capital outlays. The court found that no new costs were incurred to extract the ore (Denison would
have extracted it anyway, whether or not to create passageways), nor was any new property created
(rather, property—the ore—was taken out). In Johns-Manville, 1985, a mining company bought land
at the perimeter of its open-pit mine to allow it to expand and to keep its road in operation. The tax
authorities contended that this acquisition became part of the capital cost of the mine. The company
contended that it was a current expense. The court agreed. The land did not produce anything
permanent or enduring. Acquiring land was a constant cost, as the land was consumed for the
purposes of expanding the bottom of the mine. The company did not acquire a new asset since the
land disappeared as the mine expands. It is to note that it would have been very bad had the
company lost this case: first, it would not have had the benefit of declaring the land as a current
expense, and second, because land is not depreciable as a capital cost (see below), it could not have
benefited from CCA.
Intangible assets
In Dominion Natural Gas, 1940, the company was fighting an injunction to stop them from selling
natural gas in a particular municipality, in which they contended they had a perpetual license to sell
natural gas. The company hired a lawyer to defend the injunction, and wanted to deduct the cost. The
court held the expense to be a capital outlay. It said that the cost was incurred to protect an enduring
benefit (to preserve/protect the intangible asset). The problem is that the court equated the
protection of an enduring benefit with bringing a new asset into existence and this case produced a
most unfortunate result in terms of the cohesiveness of the jurisprudence. It is hard to reconcile this
case with other cases dealing with repair expenses, which are current expenses.39 In Kellog, 1942, a
competitor alleged that Kellogg misused the “Shredded Wheat” trademark. Kellogg defended its use
Denison would have received preferable tax treatment by calling the expenses capital outlays. It
could defer the expenses into future tax year when it would have to begin paying tax.
39 Deal with it by distinguishing it (such as the expenses are not legal expenses).
38
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Summary by Pascal Archambault-Bouffard for Allard’s Fall 2010 Taxation course
37
of the mark and sought to deduct the legal fees as current expenses. The court allowed it. It reasoned
that the company was not asserting a “property” right in comparison to Dominion Natural Gas, which
could then be distinguished. No new asset was brought into existence or repaired. The company did
not get a material advantage except the re-affirmation of a right or advantage already in existence. As
it were, the costs of the litigation were not incurred for the purpose of acquiring an asset to earn
future profits.40 In Canada Starch, 1968, the company paid $15,000 to induce another company to
drop its trademark opposition. The tax authorities argued that this was like bringing the trademark
into existence, and was a capital outlay. The court disagreed. The court it must look at the situation
from a business perspective. The test to be applied is as follows:
(1) Expenses for the acquisition or creation of a business entity or structure are capital outlays;
(2) Expenses to maintain the process or operation of profitmaking are current expenses.
The court pointed out that a trademark is not created by registration, but by its use. It is not a capital
asset that is acquired, because underlying the trademark is the goodwill of the business. If you go out
and buy a trademark, the goodwill acquired is a capital outlay. If you protect the trademark by
defending claims, the expense is a current expense.
Repair of tangible assets
The courts make a distinction between repairs, which are current expenses, and improvements or
upgrades, which are capital outlays. In Canada Steamship, 1966, the company wanted to deduct the
cost of replacing the floors and the walls in its ship. It also wanted to deduct the cost of replacing its
boilers. The ships are capital assets and the capital authorities argued that the repairs were capital
outlays. The court said that only the costs to replace the boilers are capital outlays. It reasoned that
the walls and floors needed to be replaced. It was a repair, not an upgrade: the ship survived as the
same ship—it did not become different in kind from what it was—and therefore these are current
expenses. The amount of the costs to the taxpayer are not relevant, unless they show that the
expenses incurred were for upgrades, which might suggest that a new asset was being brought into
existence. Ironically, the court was bound by precedent to hold that boilers constitute separate assets
and thus capital outlays even though they are integral to the ship. In Shabro, 1979, the company’s
apartment building was built on landfill. The ground floor started to sink and the company replaced
it, with a reinforced concrete floor. The court found that that was a capital outlay. Even though the
installation of the piles and concrete floor was necessary to preserve the value of the building (this
ensured that the building was a long-term usable asset), the floor was a permanent addition that had
not previously existed and it was not a mere repair. The taxpayer replaced a substantial part of the
building—and so it was considered an upgrade. In Goldbar, 1987, an exterior wall of the company’s
apartment building needed to be replaced. The company replaced the wall with metal cladding, a
new technology of material. The court found that that was not a capital outlay. The court emphasized
the taxpayer’s purpose, while conceding that most repairs will produce at least some enduring
benefit. The expenditure was not a voluntary expenditure made with a view of bringing into existence
a new asset. Because it used new technology, one could argue that it was an upgrade, but it would be
foolish to prevent people from using new available and better technology when they have a repair
something. Besides, the expenditure represented a small (3%) proportion of the value of the asset,
which tended to show that it was only a repair. Nothing in the project attempted to change the
structure of the building.
Capital cost allowance
Paragraph 20(1)(a) allows a taxpayer to deduct an amount to reflect depreciation under the title of
capital cost allowance (CCA). An amount must be prescribed by the regulations to be deductible, but
no deduction is permitted for expenditures that are not for the purpose of earning income or that are
of a personal nature (reg. 1102(1)(c)). Reg. 1100(1)(a) outlines the rate of the deductions. Capital
costs are deductible at year’s end, as a % of the value, and on a class basis—not on an asset-by-asset
Since the mark SHREDDED WHEAT is descriptive, no one can claim a trademark over it, so there
were no “rights” in issue in this case per se.
40
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basis. 41 Under s. 1102(1) and (2) of the Regulations, the Legislature has clarified the following rules:
one can’t deduct CCA for…
 Assets the cost of which are currently deductible (1102(1)(a));
 The cost of inventory (1102(1)(a));
 Certain types of property including land, shares, and debentures. (1102(2))
Under Schedule II, the act generally permits the use of one of the following depreciation methods:
 The declining balance method, under which the annual amount of depreciation is based on a
fixed percentage of the asset’s written-down cost (after taking into account depreciation
from previous years), is used for all classes, except…
 Class 13 (leases and leasehold improvements, which are amortized evenly over the span of
the lease, and the first renewal term) and Class 14 (intangible assets such as patents and
franchises, which are amortized evenly over the useful life of the property) use the straightline method.
A taxpayer does not have to take a CCA in a given year. The taxpayer may postpone taking the CCA;
however, it cannot accumulate CCA deductions over multiple years, and deduct the accumulation all
at once, because the amount claimed in a year is limited to the % of the asset’s written-down cost or
“undepreciated capital cost” (UCC) at the end of that year.
Calculation
Reg. 1100(1)(a) outlines the rate of the deductions, which is the appropriate % of the UCC of each
class of depreciable assets. The UCC at a given time is determined by the application of the formula in
subsection 13(21) (see below).
The half-year rule (reg. 1100(2)) restricts, in the year of purchase only, the CCA on new
assets in the class to one-half of what would normally be deductible. 42 The CCA is calculated for that
year on the basis of a notional UCC, which is determined thus:
 Notional UCC = Year-end UCC – ½ (acquisitions – dispositions in the year)
o If dispositions in the year exceed acquisitions, the half-year rule does not apply
Example: the taxpayer buys 3 busses for a total of $75,000 for business use…
1. Busses are part of class 10 (30% rate)
2. Year-end UCC is $75,000
a. 13(21) formula is: UCC = (A + B) – (E + F)
b. A (cost of the property): $75,000
c. B (previous recapture): nil
d. E (CCA previously claimed): nil
e. F (POD – expenses of disposition, up to cost): nil
3. Does the half-year rule apply? Yes, because acquisitions (additions to A) exceed dispositions
(additions for F).
a. Notional UCC = $75,000 – ½ ($75,000 – 0) = $37,500
4. Taxpayer can claim $11,250 worth of CCA
a. Notional CCA at 30%
Over three years…
A+
41
42
Year 1
Year 2
Year 3
Acquires 3 buses Sells bus #1 for Buys a $50,000
for $75,000
$18,000
bus, sells bus
for $15,000
$75, 000
$75, 000
$125,000
Total Capital Costs
Certain passengers vehicles and rental property above $50,000 are treated separately, p. 507
For policy reasons, see p. 508
38
Summary by Pascal Archambault-Bouffard for Allard’s Fall 2010 Taxation course
B-
$0
$0
$0
E-
$0
$11,250
$24,975
F
$0
$18,000
$33,000
Recapture
(usually $0.00)
Accumulated CCA
Sum total $37,500
$45,750
Rate
0.30
0.30
Lesser of capital
cost or proceeds
of disposition
0.50 ($50,000 - For new property
$15,000)
= acquired or old
$17,500
property sold; (AF)>$0, s. 1102(2)
$49,525
(A+B) - (E+F) –
0.50(addition to A
– addition to F)
0.30
CCA
$11,250
$13,725
$14,857
0.50
F)
(A- $37,500
n/a
39
Finally, if the taxation year is a shortened one (because the business is starting up), the taxpayer has
to pro-rate the CCA that year, per 1100(3).
Disposition of depreciable assets (recapture or terminal loss)
Sometimes there are no assets in the class, but the UCC is positive at the end of the year—
that is, there actually was a greater decline in value than CCA claimed. The positive balance that
arises in these circumstances is fully deductible as a terminal loss under subsection 20(16). If the
UCC shows a negative balance, whether or not there are still assets in the class, that means the assets
did not, in reality, depreciate as quickly as it is written off for tax purposes. In that case, the negative
balance is brought into the taxpayer’s income under 13(1)—the amount thus added is called
recapture. Recapture is treated as business income. Since the CCA system uses the class method,
recapture can be deferred if the class is suitably “replenished” prior to the end of the taxation year in
question (i.e., maintaining a positive UCC). Any previous terminal loss or recapture with respect to
that class must be incorporated into the computation of UCC.
By limiting the amount to no more than the capital cost of the asset, 13(21) prevents the
inclusion in income of the amount by which the proceeds of disposition exceed the original cost of
the property. This excess is taxed as a capital gain.
When the taxpayer has more than one source of business or property income, the taxpayer
must separate the classes for each source. Furthermore, under s. 1101(1ac), the act requires that the
taxpayer put each building used for rental purposes with a value over $50,000 in separate classes.
How do we assess capital cost allowance for gifts and non-arm’s-length transactions? For tax
purposes, a gift is a gratuitous transfer of property. A sale at an under-valuation is not a gift (Littler,
1978). Subsection 69(1) deals specifically with both gifts and sales. On a gift of anything, the donor is
deemed to receive POD equal to FMV and the donee is deemed to have acquired it at a cost equal to
that value. If property sold in a non-arm’s-length transactions (NALT) and the actual selling price is
greater than FMV, the proceeds to the vendor remain the selling price but the deemed cost to the
purchase is FMV. If the actual price is less than FMV, the deemed proceeds to the vendor are FMV but
the cost to the purchaser remains the actual cost. There is no explicit provision for an offsetting
correction for the other party.
Replacement property rules (re CCA)
Sometimes a taxpayer intends to replace a depreciable property, but it unable to do so before the end
of the year. Subsection 13(4) permits the deferral of recapture where the disposition was involuntary
or the property disposed of was a “former business property.” Subsection 13(4) applies only where a
“replacement property,” defined in 13(4.1), is acquired within a specified period.
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Rental and leasing property restrictions
Under regulation 1100(11), the amount of otherwise deductible CCA in respect of “rental
properties” is limited to the taxpayer’s net income from all such properties, ignoring CCA. A taxpayer
is thus prevented from creating a rental property loss, or increasing a loss, through CCA. 43
The meaning of “cost”
Although undefined in the act, the “cost” of an asset is ordinarily the amount expended to acquire it.
In Ben’s, 1955, Ben’s acquired a neighbouring piece of land with three buildings. Ben’s allocated
$39,000 for the purchase of the buildings (to be used for capital cost allowance) and $3,000 for land
(which is ineligible for CCA). The tax authorities claimed that the entire $42,000 was dedicated for
the purchase of the land, because Ben’s had no intention to using the buildings to generate revenue.
The court agreed. The courts have to look at the real commercial purpose of the transaction. The
taxpayer acquired the property to build an extension to their business. Under Reg. 1102(1)(c), for
the property to be depreciable, it must be used to earn income from business or property. Ben’s never
intended to use the building in that way—they only wanted to tear them down!
Section 68 allows the tax authorities to change the allocation of proceeds of disposition, if
the authorities consider the allocation unreasonable (see Ben’s). It applies to any property,
depreciable or otherwise (Golden, 1986). This provision is generally not used for arms-length
transactions, because the parties determine for themselves the purchase price. The tax authorities
may use section 68 for arm’s-length transactions involving tax-exempt authorities (e.g. charities).
There are several situations in which the general principle of what cost is does not apply:
gifts or bequests, property originally acquired for a purpose other than to produce income, property
used partly for the purpose of gaining or producing income, non-arm’s-length sales or transfers,
passenger vehicles… see p. 517-518 for the rules that apply in that case.
When is depreciation property acquired?
Often, the question will be whether an asset was acquired and a “cost” incurred before the end of the
taxation year or in the following year. Capital property is acquired when the expense is incurred and
the taxpayer acquires the incidents of the title (i.e. possession, control, benefits, title, risk, etc.). Mere
retention of the title by the seller to guarantee payment will not prevent acquisition for tax purposes.
The agreement of parties dealing at arm’s length bears great weight (Warden, 1969, Henuset, 1977).
Subsection 13(26) provides that, for the purposes of paragraph 20(1)(a) and the related
regulations in calculating the maximum CCA available—not the determination of recapture or
terminal loss—no addition may be made to the UCC of a class in respect of the acquisition of property
until the property has become “available for use” by the taxpayer.
Under section 13(28), the Act explains that a building is available for use when:
a) The time at which all or substantially all of the building is used by the taxpayer for its intended
purpose
b) The time at which the construction of the building is complete
c) The time which is the beginning of the first taxation year commencing more than 357 days after
the taxation year in which the property was acquired (2-year rolling start rule, see timeline).
d) The time immediately before the property is disposed of by the taxpayer
Therefore, even if construction is incomplete, the taxpayer can deduct the CCA under the 2-year
rolling start date. The ½-year rule also does not apply to property added to a class under the twoyear rolling start rule.
43
See p. 515 for more info
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For a motion picture to be deductible under CCA, it must be a motion picture film ready to be
shown to the public (Thomas, 1981).
Eligible capital expenditures (ECE)
For the tax treatment of certain intangible assets (like goodwill), eligible capital expenditure (ECE) is
the equivalent to CCA. Subsection 14(5) includes in ECE the portion of any outlay or expense made
or incurred, as a result of a transaction occurring after 1971, on account of capital, for the purpose of
gaining or producing income from a business—the cost of tangible property and intangible
depreciable property (like patents and franchises), as well as any property for which a deduction is
otherwise provided, are excluded, among others. Generally, the most frequent expenditure will arise
for goodwill, customer lists, some franchises and expenses of incorporation and reorganization.
14(5) operates in conjunction with paragraph 20(1)(b) to create a system that has
attributes similar to those of the CCA and capital gains systems. There is only one class of assets,
called “cumulative eligible capital” (14(5)). ¾ of an eligible capital expenditure is added to this
account and ¾ of the POD (called “eligible capital amount”) is deducted from the account. Under
20(1)(b), the taxpayer may deduct up to 7% of the balance in the account at the end of the year. The
amounts deducted reduce the balance of the cumulative eligible capital account so that the deduction
under paragraph 20(1)(b) is calculated on a declining-balance basis. Where the aggregate of the
deductions in computing cumulative eligible capital exceeds the additions, subsection 14(1) requires
the excess to be included in income at the end of the taxation year.
Similarity between eligible capital expenditure system and CCA system:
 CEC = UCC
 ECE = CC
 ECA = POD
 Depreciation = CCA
Example: assume that a taxpayer buys goodwill in year 1 at a cost of $10,000 and deducts the
maximum amount possible for years 1, 2 and 3. Assume further that the taxpayer sells the goodwill in
year 4 for proceeds of (a) $18,000 or (b) $6,000.
a) Addition in year 1 of ¾ of $10,000 ($7,500), and deduction of 7% ($525), with a balance
of $6,975. In year 2, the deduction (of 7% of the balance) will be $488, giving a new
balance of $6,487. Same deal in year 3 for a balance of $6,033. In year 4, the sale for POD
of $18,000 (net gain of $8,000) will deduct ¾ of that amount from CEC ($13,500).
Because you it sold for more, this will trigger recapture (treated as business income):
hence included in income will be the total of the deductions from previous years
($1,467) plus a taxable capital gain of $4,000 because 14(1)(b) ensures that the amount
of any income inclusion that effectively represents appreciation in the value of the
property is recognized at the one-half capital gain rate.
b) For this example, the steps for the first three years are the same. In year 4, the sale for
POD of $6,000 (net loss of $4,000) will deduct ¾ of that amount from CEC ($4,500). In
this example, no amount is required to be included in income under 14(1). There is a
positive CEC balance of $1,533.
If the business is discontinued and there is a positive CEC balance, the taxpayer may be entitled to an
immediate deduction equal to that balance in the year in which the business ceases (24(1)).44
In Royal Trust, 1982, the company raised capital by selling shares. The receipt of the
investment money is a capital receipt. The company had to pay a fee to the underwriters and wanted
to deduct the fee as ECE. The court allowed it, saying that the commission was the cost of raising
capital and therefore a capital outlay. The specific expenses in that case are now treated as a
deductible expense under 20(1)(e). In Saskatoon Drug, 1978, the company wanted to attach
goodwill to a lease, so that it can deduct CCA from its cost. The taxpayer paid a premium for the
leases on top of the balance of the rent because of the goodwill attached to the location. The court
found that that was a capital expenditure. The court concluded that the premium was part of the cost
44
If subsequently carried on by a spouse or corporation controlled by the taxpayer, see p. 525
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to acquire the lease. The company had clearly bought something intangible, the price of which was
determined at arm’s length. The lease conferred the taxpayer the goodwill of the location, so it
formed part of the cost of the lease. Had this case been decided today—now that goodwill can be
deducted as ECE—the result might have been different.
TAXATION OF CAPITAL GAINS AND LOSSES
Prior to 1972, capital gains were tax exempt. Now, they are taxed at 50% of the gain but deductible at
50% of the loss. The retention or use of property does not give rise to a capital gain; only the
disposition of property does. Property that is used to produce business or property income, when
sold, can also give rise to a capital gain.
Capital gains currently received a very favorable treatment under the ITA. A capital gain may
occur on the sale of a capital property such as shares or land held as an investment. Similarly, a
capital gain may arise in a business context such as upon the sale of a fixed capital asset used in a
business. In the personal context, a capital gain may arise on the sale of a valuable painting held for
investment or enjoyment.45 For income purposes, only half of the gain is included—likewise, only
half of the loss can be deducted, and are deductible only from capital gains. Allowable business
investment losses, which may be deducted against all sources of income, recognize the need for more
generous tax relief for losses on venture capital investments in small businesses (paragraph 3(d) and
38(c)). However, with the reduction of the capital gains inclusion rate to one-half, the preference
attached to ABIL is similarly reduced.46
Capital gains/losses vs. adventure or concern in the nature of trade
Most of the cases dealing with the distinction between business income and capital gain turn on
whether a transaction can be characterized as an “adventure or concern in the nature of trade”
(ACNT). IT-459 provides a convenient summary of the jurisprudence:47
 As a rule, when a person habitually does a thing that is capable of producing a profit, then he is
carrying on a trade or business notwithstanding that these activities may be quite separate and
apart from his ordinary occupation. Where such a thing is done only infrequently, or possibly
only once, rather than habitually, it is still possible to hold that the person has engaged in a
business transaction if, in accordance with the definition of “business” in subsection 248(1), it
can be shown that he has engaged in “an adventure or concern in the nature of trade.” However,
someone can engage in an adventure or concern in the nature of trade without necessarily
“carrying on” a business (Vancouver Art, 1993). A determination is made based on the degree of
activity and each situation must be considered in the light of its own particular facts.
 No single criterion can be formulated. All the circumstances of the transaction must be
considered. Generally, however, the principal tests that have been applied are as follows:
a. Whether the taxpayer dealt with the property acquired by him in the same way as a
dealer in such property ordinarily would deal with it;
b. Whether the nature and quantity of the property excludes the possibility that its sale was
the realization of an investment or was otherwise of a capital nature, or that it could
have been disposed of other than in a transaction of a trading nature; and
c. Whether the taxpayer’s intention, as established or deducted, is consistent with the
other evidence point to a trading motivation.
 Taxpayer’s Conduct: the primary consideration is whether the taxpayer’s actions in regard to the
property in question were essentially what would be expected of a dealer in such property. The
court will therefore compare was dealers in the same kind of property ordinarily do with what
the taxpayer did when he purchased the property, when he sold it and during the time when it
For policy re CG, see handbook p. 531-531
For the lifetime exemption and varying inclusion rate schemes and dates, see p. 533 / for policy on
the inclusion of capital gains in income, see p. 536
47 See p. 537-540
45
46
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
48
43
was in his possession. Efforts to attract purchasers or a sale that took place within a short period
of time after the acquisition of the property points to a trading intention. Steps taken to improve
the marketability of the property during the time the taxpayer owned it suggest that it is more
than a mere investment. (See Irrigation Industries and Taylor, below).
Nature of the Property: where property is acquired by a taxpayer is of such a nature or such a
magnitude that it could not produce income or personal enjoyment to its owner by virtue of its
ownership and the only purpose of the acquisition was a subsequent sale of the property, the
presumption is we are dealing with an ACNT. If the taxpayer is not in a position to operate it and
could make use of it only by selling it, the presumption again is ACNT. Some kinds of property
(e.g., a business, shares) are prima facie of an investment nature in that they are normally used to
produce income through their operation or mere possession. Where the taxpayer could have
operated or held such property, but chose to sell it, the governing factors will be his conduct as
he dealt with it and intention when he acquired it.48 (See Irrigation Industries and Taylor,
below).
Taxpayer’s Intention: intention to sell at a profit is not sufficient for ACNT (see Irrigation
Industries). Where the above tests suggest an ACNT, and it can be established that the taxpayer’s
intention was to sell the property at the first suitable opportunity, that will be considered
corroborative evidence. Yet, inability to establish intention to sell does not automatically prevent
something from being an ACNT. A taxpayer may have more than one intention when a property is
acquired. If the primary intention is said to be the holding of the property as an investment,
regard must be had to whether, at the time of the acquisition, there was a secondary intention to
sell the property if the primary intention could not be fulfilled. This is particularly significant
where there is little likelihood of the property being retained by the taxpayer (say, because of a
lack of financial resources). Finally, a taxpayer’s intentions are not limited to the purpose for
acquiring the property but extend to the time at which the disposition was made. That is, it may
change at any time during ownership. In California Copper, 1904, a company bought a copper
field on speculation. They did not have sufficient capital to develop it. They sold it to another
company. The court found that this constituted an ACNT because it was manifest that the
company never intended to work the mineral field with the capital at its disposal, and its purpose
was to induce others to take it up on such terms as would bring substantial gain. In Regal
Heights, 1960, a company purchased land outside of Calgary to build a shopping centre. They
talked to city officials about zoning. They made sketches, a list of clients, and discussed financing.
They soon discovered that another person was building a mall a few miles away, and they
abandoned their project. They sold the land at a profit. The court held that it was an ACNT. While
the primary purpose of the taxpayers was to build a shopping mall, they did not sign up tenants
or obtain sufficient capital. Their efforts turned out to be no more than promotional in character,
and failed, and their secondary intention was to sell the land at a profit if the mall business did
not work out, which is what they did. In Riznek, 1979, the taxpayer was assembling land with the
intention of building a shopping plaza. When the owner of a small parcel of land changed his
mind at the last moment, the development was frustrated, and the taxpayer sold part of it at
profit in response to an unsolicited offer. The court held that the transaction was not an ACNT as
there was no evidence of any secondary intention at the time of purchase to resell if things didn’t
work out. In Regina, 1984, the circumstances were analogous to those of Regal Heights, except
that the tax court said that a secondary intention did not arise until the time that the primary
intention was frustrated. However, intention to sell for profit after the time of acquisition was
sufficient to characterize the whole gain as income from an ACNT. Then, on appeal, the court
found that the secondary intention existed at the time of acquisition. In Hughes, 1984, the court
divided the profit between business income and capital gains. Hughes bought an apartment for
the purpose of renting out the units. When that plan became unfeasible, she converted the
apartment into condos and sold them. The growth in value attributable to the time between the
original purchase and the decision to convert the units was treated as a capital gain; afterward,
revenue was treated as business income, because she sold “inventory.” Again, the secondary
For rules on TFSA re corporate shares and real estate, p. 550
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intention of the taxpayer, even if it occurred after acquisition, was to sell the building for a profit,
which triggered business income.
 Isolated Transactions: the following factors, in and of themselves, are not sufficient to prevent a
finding that a transaction was an ACNT:
o The transaction was a single or isolated one (see Taylor, below).
o The taxpayer did not create any organization to carry out the transaction
o The transaction is totally different from any of the other activities of the taxpayer and he
never entered into such a transaction either before or since
 Losses: if a taxpayer suffers a loss while on an ACNT, then that loss is a loss from business and
enters into the calculation of the taxpayer’s non-capital loss for the year.
In Irrigation Industries, 1962, the taxpayer bought shares in a mining company issued at an IPO.
The shares were highly speculative in nature, because the mining company was starting up. There
was no chance of payment of dividends in the foreseeable future. The taxpayer’s intention was to sell
the shares at a profit. The investment was under-capitalized as the taxpayer sold some of the shares
after only a few months to repay the loan used to finance the original purchase. The court admitted
that “where the realization of securities is involved, the taxability of enhanced values depends on
whether such realization was an action done in the carrying on of a business.” The court said that it
was not significant that the company borrowed funds to purchase the shares, that there was no
immediate likelihood of dividends, and that the company entered into the transaction with the
intention of disposing of the shares at a profit so soon as there was a reasonable opportunity of so
doing. An accretion to capital does not become income merely because the original capital was
invested in the hopes and expectations that it would rise in value; if it does so rise, its realization
does not make it income (Lord Buckmaster). What would be determinative are the company’s
conduct and the nature and quantity of the subject matter of the transaction. The court said that
corporate shares are in a special position (say, as opposed to land) because they constitute
something the purchase of which is, in itself, an investment—they are not, in themselves, articles of
commerce (however, contrast this position with the ruling in Ludco, p. 29, where an investment in
shares was found to produce business income). There acquisition is a well-recognized method of
investing capital in a business. Only a person engaged in the business of trading securities would
have business income from the sale of shares. The company in this case could not be said to have
acted as a dealer of shares ordinarily would because they only bought shares directly and then sold
them, presumably through brokers. They did nothing more (the purchase was not an underwriting,
nor was it a participation in an underwriting syndicate for the purpose of effecting their sale to the
public, etc.). This is characteristic of an investment, pure and simple.
In Taylor, 1956, Taylor was the president of a company. His company needed lead, but it was
only authorized to purchase a 30-day supply, so Taylor bought lead himself, and resold it to the
company at a profit. The court said that this resulted in business income for Taylor. The court also
said that “the very word ‘adventure’ implies a single or isolated transaction and it is erroneous to set
up its singleness or isolation as an indication that it was not an [ACNT].” With regards to intention, it
was obvious that Taylor bought it solely for the purpose of selling it to the company, and not to hold
it as investment. All his reasons were business reasons. His transaction was dealing in lead and
nothing else. With regards to his conduct, he dealt with the lead in exactly the same manner as any
dealer in imported lead would have done: he bought it from abroad and sold it to a user in Canada.
Taylor merely did what his company would have done if it could (and his company would have been
taxed as a dealer). Also, in this case, “the nature and quantity of its subject matter, namely, 1,500 tons
of lead requiring 22 carloads to carry it, excluded any possibility that it was of an investment nature
involving the realization of a security or results in a fortuitous accretion of capital or was otherwise
of a capital nature.” The court also emphasized that “the speculative element is of particular
importance when it is coupled with the finding that the sale of a property, which by itself is
productive of income and might be regarded as an investment, can be a trade in the property rather
than a realization of an investment.” Here, Taylor saw advantages of a business nature in the
transaction and these outweighed with him the risk of loss which he undertook.
Finally, in Canadian Marconi, 1986, the SCC held that, where income is received or
generated by an activity done in pursuit of an object set out in the corporation’s articles or
incorporation, there is a rebuttable presumption that such income is from a business. In Friesen,
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1995, the court said that the first requirement of an ACNT is a transaction of purchase and sale
involving a “scheme of profit-making.” In the end, the court will assess: (1) frequency of the
transactions, (2) quantity of the property, (3) length of time it is held, (4) skill of the taxpayer, (5)
time spent trading, (6) circumstances surrounding the trading.
Section 39(4) allows a taxpayer to elect to characterize gains and losses from the
disposition of Canadian securities as capital gains and losses. A Canadian security is, pursuant to
section 39(6) a security in a corporation resident in Canada or debts issued by residents of Canada.
Section 39(5) prohibits traders or dealers in securities (and financial institutions) from benefiting
from this exemption. In Vancouver Art, 1993, the court said that it will look at contextual factors
such as the frequency of the transactions, the duration of the holdings (a quick profit or long-term
investment?), the intention to acquire for resale at a profit, the nature and quantity of the securities
held or made the subject matter of the transaction, the time spent on the activity to determine whether
the taxpayer is a dealer under section 39(5). The skill and knowledge of the taxpayer is also
important, as “it is a badge of the trade that a person who habitually does acts capable of producing
profits is engaged in a trade or business.”
The capital gains framework
Paragraph 40(1)(a) provides that a gain equals the amount by which a taxpayer’s proceeds realized
on a disposition of property exceeds the adjusted cost base (ACB) and any associated expenses of
disposition. Conversely, paragraph 40(1)(b) defines a loss as the excess of the ACB of a property and
any expense of disposition over the proceeds of disposition (POD). The concept of net gains or losses
contains four key elements:
1. ACB
2. Disposition
3. POD
4. Expenses of disposition
Cost
The ACB of depreciable property at any given time is its capital cost (CC) to the taxpayer as of that
time (section 54, “adjusted cost base,” paragraph (a)), whereas the ACB of capital property other
than depreciable property is its cost, adjusted as of the relevant time in accordance with section 53
(section 54, “adjusted cost base,” paragraph (b))
Capital cost and actual cost
The government considers CC to mean the full cost to the taxpayer of acquiring depreciable property,
including costs like legal, accounting, engineering and other fees (IT-285R2). The cost of property
includes all amounts paid, and debts incurred, to the vendor at the time of acquisition. For a debt
incurred by the taxpayer for form part of the cost, it must be a “real” debt, not a contingent liability.
Amounts paid to the vendor by third parties are not included in the cost. The CC of depreciable
property must be reduced by the amount of any investment tax credit or any government
assistance.49 Capital expenditures to improve property after acquisition are also included in its cost.
Capital expenditures must be in money or money’s worth; the taxpayer’s own labor in improving the
asset will not increase its cost base. Costs of ownership are not added (i.e. interest to service the loan,
municipal property taxes, maintenance and repairs). However, under section 21, the taxpayer can
add interest and burrowing costs to the CC of depreciable property and depreciate the interest in the
CCA system, instead of deducting it as a current expense. 50 In barter transactions, determining the
cost of the new property is problematic. If property difficult to value is acquired in exchange of
property that’s easy to value, there is a presumption that the properties have the same value, and
accordingly the cost to the taxpayer of the former property is the value of what the latter property. If
the property given up or the services rendered can be easily valued, that value will be the cost of the
acquired property. Here are some examples:
49
50
For electing to reduce the cost because of a grant, reimbursement or other assistance, p. 560
For deductions of interest on “raw land” and construction costs, see p. 560
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1.
2.
3.
46
The taxpayer offers a prospective executive the offer to buy his shares to induce him to take the
job. The taxpayer reneges on the offer and the executive sues. The taxpayer pays $1.3 M to settle
and keep the shares. This money is paid to preserve the title and can be added to the CC. If the
taxpayer’s company is taken over and fails to disclose the settlement (fraud) and settles the
second case for $2.5 M, that money cannot be added. Title to the shares was never in issue. The
shares were not at risk.
Mortgagor owed $50,000 in interest. The mortgagee purchases the property for $150,000, but
paying only $100,000 to reflect the debt. The creditor’s cost to acquire the property is $150,000.
Taxpayer buys bonds for $1,200, of which $200 representing interest accrued. The buyer must
declare the income under section 9, but can deduct the interest already accrued under section
20(14). Under section 53(2)(e), the taxpayer has to reduce the amount of the interest from the
capital cost, yielding a result of $1000.51
Cost of Property Acquired Before 1972
When property that was acquired before the new system came into effect is disposed of, the “presystem” gains and losses—those accrued before 1972—are excluded from the “post-system” gains
and losses so that only the post-system ones are included. The proposition is simple, but the rules
complicated. They are contained for the most part in section 26 of the Income Tax Application Rules.
The following four main areas of capital transactions are covered by different sets of rules:
(1) Arm’s-length transfers of non-depreciable capital property (section 26(3) of ITAR)
a. The elimination of pre-system gains and losses in this situation is achieved by fixing the
property’s cost base to be either
i. “The median value” or “tax-free zone”
ii. The “V-day value” or “FMV on valuation day” (V-day is Dec. 22, 1971 for shares,
and Dec. 31, 1971 for all other property)
b. Corporation and partnerships use the first method, and most individual will probably
prefer it as well. The basic idea of the tax-free zone is simple: any change in value after
Dec. 31, 1971 is treated as a gain or a loss only to the extent that it is a “real” gain or loss
compared with original cost. In the standard case, this is achieved by deeming the cost of
property to be the median of three amounts:
a. Actual cost
b. FMV on V-day
c. Proceeds of disposition
c. Example: if the cost of the property was $30, the V-day value, $40, and the proceeds, $60,
the rule protects the increase between $30 and $40. If the cost of the property was $30,
the V-day value $20, and the POD $40, only $10 is considered a capital gain.
(2) Arm’s-length transfers of depreciable capital property (ITAR 20(1)(a))
a. Here, there is no problem with capital losses, since they cannot occur on depreciable
property (we have a terminal loss instead). We’re only concerned with capital gains. The
POD will be reduced by the amount of the pre-system gain. The proceeds of disposition =
capital cost + amount in which the proceeds > V-day value.
i. If the V-day value was higher than the original cost, and POD were higher than
V-day value, the POD are deemed to be the capital cost plus the difference
between actual proceeds and V-day value.
ii. If V-day value was lower than capital cost, but POD were higher, the ordinary
rules of depreciable property apply: actual POD compared with original cost.
(3) Non-arm’s-length transfers of non-depreciable capital property (ITAR 26(5))
a. The rules provide for the transfer of a taxpayer’s tax-free zone to any non-arm’s length
transferee, and from that transferee to a further non-arm’s length transferee, and so on
as long as the chain of non-arm’s length transfers remains unbroken.
(4) Non-arm’s-length transfers of depreciable property (ITAR 20(1)(b))
51
See p. 565
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So long as the chain is unbroken by an arm’s length transaction or a transfer on death,
each successive owner of the depreciable property has a deemed capital cost, for
purposes of CCA and recapture, that is reduced by the amount of the untaxed pre-system
gain.
Deemed cost of property acquired after 1971
In most situations, taxpayers use the purchase price (actual cost) as the primary component of the
ACB, but sometimes the ITA imposes a deemed cost instead. Depending on the transaction, the ITA
may substitute FMV, nil cost, or ACB, for the actual cost:
 FMV
o Section 69(1) deems non-arm’s length transactions, gifts, bequests, and inheritances to
have a cost equal to FMV
o Death (section 70(5)(b)): a person is deemed to dispose of property and the estate has
to declare capital gains. The legatee is deemed to acquire the property at fair market
value.
o Prizes (section 52(4)): deems the value of the prize to be the fair market value at
receipt.52
o Dividends in kind (section 52(2)): deems the value of the dividend to be the fair market
value at receipt. The receipt of the dividend is taxable as income from property.
o The taxpayer should be able to add to FMV any initial capital outlay. Example: if the
taxpayer is given a capital property with FMV of $1,000 and incurs $500 in freight
charges, the cost ought to be $1,500. However, if the outlay was made before the deemed
acquisition of the property, the taxpayer’s expenses may be excluded from the cost base
because the ITA prescribes FMV as the cost of acquisition (Allison, 1975).
 Nil cost
o Bad debts of a capital nature, or shares in a bankrupt or insolvent corporation (50(1)).
Deeming the cost to be nil renders any subsequent proceeds chargeable as capital gains
and disallows future capital losses. This nil cost is the consequence of a tax write-off in
respect of the worthless property so as to avoid the need to dispose of the worthless
shares; if the corporation becomes solvent again then the shareholder pays capital gains
on the increase in value.
 ACB
o Transfer to a spouse (Section 73(1)): in order to postpone taxation of an accrued gain
(or the deduction of an accrued lost), the ITA provides a “rollover” in these
circumstances. On a transfer, the transferee-spouse’s cost is deemed to be equal to the
transferor-spouse’s ACB. The transferor realizes no capital gain or loss, and whatever
gain or loss has accrued to the time of transfer will form part of the capital gain or loss
when the transferee disposes of the property (rollovers are discussed further).
o Transfers of fishing or farm property is treated likewise (70(9))
Adjustments to cost
A negative ACB is precluded, except in the case of certain partnership interests by subsection 40(3).
If at any time in a taxation year, deductions from cost exceed the property’s ACB immediately prior to
such deductions, the excess is deemed to be POD and a capital gain at that time. The capital gain is
then added to ACB, restoring it to zero for future gain or loss computation (53(1)(a)). The rule takes
effect at any time that the ACB notionally becomes a negative figure.
Additions to cost: amounts that relate to the value of the property and that were included in
income may be added to the cost of the property under subsection 52(1). When the asset is sold, the
amount previously included in income will reduce the amount of the gain and may create a capital
loss. Disallowed amounts, such as superficial losses, interest and property taxes and restricted farm
losses, are added to cost. Reasonable costs of surveying or valuing the property for the purpose of its
In Canada we do not pay tax on lottery or prize winnings unless they are obtained in the course of
employment.
52
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acquisition or its disposition are also added to the ACB, unless they are deducted in computing
income or are attributable to other property (53(1)(n)).
Deductions from cost: most deductions from cost are technical adjustments. If some of the
cost of property is deductible in computing income, it must be subtracted from cost for capital gains
purposes, to prevent taxpayers from deriving double relief for the same outlay (53(2)(m)).53
Disposition and proceeds of disposition (including involuntary dispositions and reserves)
Disposition and POD bear both their normal and statutory meaning. Subsection 248(1) includes as a
disposition “any transaction or event entitling a taxpayer to [POD] of property” or, as the government
sees it, “any event or transaction where possession, control and all other aspects of property
ownership are relinquished” (IT-460). The court in Cie Mobilière BCN gave the term a large scope: it
includes loss, theft, destruction, and permanent transfers of use. This section also contains a
sweeping definition of property: in principle, any right that is convertible into cash is likely to result
in a disposition when it is converted. The most obvious kind of disposition is a sale at arm’s length,
where the POD equal the sale price. Where, in respect of the property acquired, the purchaser
assumes any liability or encumbrance, it would form part of the vendor’s proceeds of disposition and
of the purchaser’s cost. The government takes the position that if the vendor promptly assigns
considerations such as a promissory note, mortgage or agreement for sale, only the received rather
than the face amount would be included in the proceeds. For example:
 The purchaser sells property for $10,000. He receives $5,000 in cash and a $5,000 mortgage. The
vendor sells the mortgage immediately for $4,000. The proceeds of disposition are $9,000. By
combining the transactions or by breaking them apart, the result would be the same.
 The developer has a claim against the purchaser for $65,000 on the construction of an
immovable. The purchaser sells the immovable back to the developer. The proceeds of
disposition include the $1 cash, the $160,000 bank mortgage which the developer assumes from
the purchaser, and the $40,000 waiver of the promissory note. The $65,000 is not treated as part
of the proceeds of disposition unless the developer could prove an absolute right (either by
demurrer or by judgment). In this case, the developer only had a claim, but no right.54
 Frank acquires shares in X Co from Charlie for $7.8 million. Charlie agrees to buy a $1.4 million
debt from X Co for $600 thousand (fair market value). The proceeds of disposition of the shares,
therefore, is $7.8 million - $1.4 million + $600 thousand (or $7 million). Charlie was required to
acquire the debt as a condition of the sale of the shares. The interest that the debt produces then
forms part of Charlie’s income, while repayment of the capital may in future trigger a capital gain
if the debtor pays Charlie more than $600 thousand.
The sale price of property would include the value of any non-cash consideration such as property or
services. A sale by court order involves a transfer of property to another for consideration (Corbett,
1997). A “disposition” also includes involuntary transfers such as expropriation, where the
compensation paid is the proceeds. Where a property has been unlawfully taken, destroyed or
damaged, the taxpayer is treated as having disposed of it for the amount received by way of
compensation (say, a non-tortious damages award) or insurance. However, where property is
damaged, the taxpayer may exclude from proceeds any amount spent within a reasonable time to
repair the damage (section 54, “proceeds of disposition” paragraph (f)). More examples:
 Expropriation: if you own Blackacre and Whiteacre, and Whiteacre is expropriated, which also
results in a decrease in value for Blackacre, you will be entitled to compensation for both the
expropriation of Whiteacre and the damages to Blackacre. Thus the ITA provides for separate
dispositions of the two pieces of land for proceeds equal to the compensation in respect of each
property.
 Conversion of property from capital to inventory: no disposition at the time of the decision but
when the property is sold: the taxpayer will have to calculate both the trading profit, and the
capital gain. The trading profit will be computed on a notional cost of acquisition equal to the
FMV of the property at the time it was converted to inventory. The capital gain will be based on
53
54
See p. 565 on bonds and other interest-earning obligations
See p. 566 for my own notes on this
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
49
the original ACB and proceeds equal to the FMV at the time of conversion. (see Taylor above, p.
41)
A debenture or share is disposed of if the rights attached to it are altered so fundamentally as to
change the nature or identity of the property. Examples given are a change in the repayment or
maturity date of a debt, or a change in voting rights attached to shares that results in a change of
control. Remember that paragraph 50(1)(b), provides that shareholders of bankrupted or
insolvent corporations have a deemed disposition of $0.
Transactions that are not dispositions
The following transactions are non-dispositions:55
 Transfers securing a loan or debt or returning the security to the borrower
 Transfers of bare legal title: transfers of property to agents or nominees without any change in
beneficial ownership.
 Transactions such as the bailment of a chattel or a lease of realty or personality (unless the
transactions are, in substance, a sale)
o Example: V leased certain property to P in 2005, and P took possession. Under the terms
of the agreement, P was obliged to purchase the property for $255,00 by the end of the
five-year term, which P did in 2010. Did V dispose of the property in 2005 or 2010? The
answer is 2005.
 Partitions of jointly owned property, but there is a part-disposition of the old undivided interest
if the FMV of the new interest is less than the fair market value of the old one.
 The granting of an option it not a disposition. If the buyer exercises the option, the price paid for
the option is subsumed into the purchase price. If the buyer does not exercise the option, the
money paid for the option is a capital gain, as the ACB for the option is deemed to be $0.
 A corporation does not dispose of anything when it issues its own stock or other securities.
However, under subsection 39(3), the issuer of any bond, debenture or similar obligation, on
purchase the obligation in the open market in the manner in which such obligation would
normally be purchased in the open market, must account for the capital gain or loss on the
purchase. Example: a corporation borrowed $100 and issued a debt instrument at a face amount
of $100 with interest at current rates to secure repayment of the loan. Because of an increase in
interest rate, the company was able to repurchase the bond for $90. The difference of $10 would
be a capital gain.
Deemed disposition
The ITA provides for certain fictional realizations, or deemed disposition at FMV:
 Change in use of capital assets from income-earning to non-income-earning and vice versa
(section 45) (see Hughes, p. 40)
 Death of the taxpayer (subsection 70(5))
 Giving up Canadian residence (paragraph 128.1(4)(b))
 Deemed dispositions by a trust of trust property every 21 years (paragraph 104(4)(b), (c))
Timing of dispositions
It is important to know precisely when a disposition takes place since it is an event that triggers the
realization for tax purposes of capital gains and losses. According to IT-170R, an entitlement to the
proceeds of disposition arises when the vendor’s right to the payment is absolute, but not necessarily
immediate. The payment must not be subject to a condition precedent. A transaction structured in a
way to defer payment to make it appear as a lease will be interpreted by the courts in its substantive
form (i.e. a capital acquisition and not a capital lease). The presence of a condition subsequent or
determinable condition do not affect the initial disposition, but may, if realize, trigger another
disposition sometime in the future if that restores ownership to the vendor or adjusts the sale price.
A condition precedent is an event beyond the direct control of the vendor that suspends completion f
the contract and that could cancel the contract ab initio if it is not met or waived. Formal agreements
55
See p. 568-570 for the rules that apply
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of purchase providing the date of exchange will be taken into account unless circumstances indicate
the date was changed or that it was not the true intent of the parties. Where no date is specified, the
time that the attributes of ownership pass from the vendor to the purchaser is presumed to be the
date of entitlement. This is also valid for depreciable property. Since possession, use and risk are the
primary attributes of beneficial ownership, registration of legal title alone is of little significance in
determining the date of disposition. Factors that are strong indicators of the passing of ownership
include:
 Physical or constructive possession
 Entitlement to income from the property
 Assumption of responsibility for insurance coverage
 Commencement of liability for interest on purchaser’s debt that forms a part of the sale price
Example: in 2010, V agreed to sell certain land to P. Part of the price was payable on a closing date in
2010, and the balance upon the fulfilling of certain conditions precedent, within two years. P had
possession from 2010. The last condition precedent was fulfilled in 2012. In this scenario, the
transfer occurred in 2010 because the condition precedent could affect only the proceeds, not the
transfer itself, and P has possession from 2010.
Part dispositions
On the sale of an entire capital property, the vendor calculates the capital gain or loss by deducting
the full amount of the ACB from the proceeds. When a taxpayer disposes of part of a capital property,
the taxpayer must deduct only a proportionate part of the total ACB from the proceeds. The taxpayer
must allocate a reasonable portion of the cost base to the part sold (43(1)). Only that reasonable
portion is deductible from the proceeds. After deducting the reasonable portion of the cost base
allocated to the part disposed of, the taxpayer allocates the rest of the cost base to the unsold part of
the property (53(2)(d)). Example: Verna purchased land for $100,000. She sells 20% of it for
$25,000. Verna’s ACB for the 20% part would be $20,000 and her capital gain therefore would be
$5,000. Following the part disposition, Verna’s ACB for the remainder of the land would be $80,000.
Combined proceeds for more than one property
Problems arise where the parties fail to make an allocation, or make one that is self-serving or
unreasonable, when a single transaction provides consideration for more than one item including:
depreciable property, non-depreciable property, services and something else that is not property,
like know-how. When that happens, the government can have recourse to section 68 to apportion to
each item the part of the amount that can reasonably be regarded as a consideration for that item. In
Golden, the taxpayer sold land and an apartment building for $5,850,00 of which $5.1 million was
allocated to the land and $750,000 to the building. The trial judge applied section 68 and allocated
$3,530,000 for the building, which would trigger recapture. The court of applied overturned the
decision, saying that one must consider the matter from the viewpoint of both the vendor and the
purchaser and to consider all of the relevant circumstances surrounding the transaction. Where the
transaction is at arm’s length and not merely a sham or subterfuge, the bargain struck by the parties
will be given great importance. The SCC sided with the court of appeal, adding that a reasonable
allocation need to be proportional to the respective FMV of the items taken by themselves, so long as
the parties dealt at arm’s length and the valuation is reasonable.
In the case of a sale of land and depreciable building, paragraph 13(21.1)(a) sets a base
amount that must be allocated to the proceeds for the building. Under that provision, a taxpayer is
not entitled to allocate proceeds from the sale of a building to produce a terminal loss when there is a
capital gain generated on the land. The taxpayer has to readjust the proceeds of disposition for the
building to an amount greater than the UCC. For example, if the sale price for land and a building was
$100,000 and the taxpayer had a UCC on the building of $50,000 and the land was bought for
$40,000, the taxpayer has to allocate $50,000 to the sale of the building. Anything less would result in
a terminal loss, which is not allowed under the provision.
Where a building is demolished shortly after or before a sale of the underlying land, the
proceeds can be allocated entirely to the land (Malloney’s, 1979). If the parties to the transaction
allocate all the proceeds to one asset, section 86 cannot apply (Robert Glegg, 2009).
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Summary by Pascal Archambault-Bouffard for Allard’s Fall 2010 Taxation course
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Rollover treatment on the reinvestment of proceeds in a replacement property
Section 44 provides non-recognition or rollover treatment for owners who receive proceeds on
certain dispositions if they reinvest the proceeds in a replacement asset and elect to defer tax until
the disposition of the replacement. The provision extends to the following dispositions:
a) Unlawful taking
b) Destruction
c) Taking under statutory authority (or sale before that happens but notice has been given)
d) Replacement of a “former business property,” which means real property or an interest therein
(except leasehold) used primarily for the purpose of gaining or producing business income
(except rent) that was disposed of in any manner.
The rationale is that the involuntary nature of the disposition makes it unfair to assess a capital gain
if the proceeds are reinvested in similar property, or to permit businesses to change location without
the disincentive of a tax liability for capital gains realized on the old premises. This provision applies
to depreciable as well as non-depreciable property, with subsection 13(4) addressing CCA
consequences (see chapter on CCA).
Section 44 requires the taxpayer to reinvest the proceeds in a replacement property within
a certain time. In cases (a) to (c), that means before the end of the second taxation year after the year
in which the POD of the former property became receivable. In case (d), that means before the end of
the taxation year immediately following the year in which the proceeds for the former business
property became receivable. For (a) to (c), subsection 44(2) deems the relevant time to be the
earliest of a number of events, including the time of reaching a settlement of the claim or the final
determination of compensation by a court. If the taxpayer has neither agreed to settle nor
commenced proceedings before the second anniversary of the loss, that anniversary date is the time
the proceeds are deemed to have become receivable. Subsection 44(5), defines replacement
property: it must be “reasonable to conclude that the property was acquired by the taxpayer to
replace the former property.” It must be bought for the same or a similar use, and used for the
purpose of gaining or producing income from the same business. The taxpayer is deemed to have no
capital gain if all the proceeds are used in acquiring the replacement property. Amounts in excess will
mean a capital gain, up to the maximum of capital gain calculated without reference to section 44.
Whatever amount of gain is exempted by operation of these rules must be subtracted from the cost of
the replacement property, so it will eventually form part of the capital gain when the replacement
property is disposed of in a taxable transaction. The rules apply only if the taxpayer so elects in the
return for the year in which the replacement property is acquired. 56
Other rollover transactions (farm prop, spouses, donation of capital prop, capital prop vs. shares)
See handbook p. 577. See also section on intra-family transactions.
Reserves for future proceeds
If the terms of sale provide for the selling price in a series of installments, the taxpayer may claim a
reserve for future proceeds (40(1)(a)(ii), (iii)). By claiming a reserve, the seller can reduce the
amount of gain in the year of disposition and can defer the balance of the gain to future taxation
years as the proceeds become due. See p. 34. The taxpayer must report the reserve claimed in the
year 1 in year 2’s tax return, and may deduct a reserve for any proceeds that will be payable in
subsequent years, and so on until the entire capital gain has been allocated to a taxation year (subject
to a limitation in time, see below). The government accepts the following formula for calculating a
reasonable reserve:
 CG multiplied by the amount not due until after the end of the year divided by POD
The taxpayer deducts this reserve in calculating the capital gain to be reported in each taxation year.
A taxpayer may choose to claim any amount up to the maximum reserve, but the amount claimed in
one year limits the amount that may be claimed in the following year. There is no obligation to claim
a reserve and a taxpayer claims a capital loss fully in the year of disposition, even though the buyer
will pay the proceeds in later years. Claiming a reserve defers reporting the vendor’s capital gain but
56
For rules on replacement of small business shares, p. 576 at the bottom
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52
has no effect on the purchaser’s ACB of the asset. A nine-year limit applies to sales to the taxpayer’s
child of family farm/fishing property or small business corporation shares. For installment sales of
other capital property, the taxpayer may claim a reserve up to a maximum of four years. The maximum
reserve for each year is the lesser of:
 CG multiplied by the amount not due until after the end of the year divided by POD
 CG multiplied by
o 4/5 (year of disposition)
o 3/5 (second year)
o 2/5 (third year)
o 1/5 (fourth year)
o 0 (fifth year)
Example: a capital property is sold for $100,000. The property had an ACB of $70,000 (thus a capital
gain of $30,000). $25,000 is paid on closing of the sale, with the balance to be paid annually in
$15,000 installments over the next five years: (see next page)
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Summary by Pascal Archambault-Bouffard for Allard’s Fall 2010 Taxation course
Sale Price (POD)
Cost to Purchase
Profit (CG)
Payment
Buyer
53
$100,000
$70,000
$30,000
Year 1
Year 2
Year 3
Year 4
Year 5
Year 6
$25,000
$15,000
$15,000
$15,000
$15,000
$15,000
$22,500
$18,000
$12,000
[$6,000]
-$18,000
-$13,500
-$9,000
by
Profit
Reserve
Carryover
—
Reserve
=
Outstanding
(Amounts
due
divided by Sale
Price multiplied by
Profit)
$30,000
-$22,500
"Alternate
Reserve"
Amount Declared
$7,500
$4,500
-$12,000
-$6,000
$6,000
$6,000
No
carryover
after
Year
5
unless
family
farm or
small
business
$6,000
Capital gain reserves require an additional calculation. The maximum reserve is the lesser
of the two reserves. It is determined by taking 0.20 * (4 - number of preceding years after
disposition).
Profit
"Alternate
Reserve"
Amount Declared
$30,000
$24,000
$18,000
$12,000
-$24,000
-$18,000
-$12,000
-$6,000
$6,000
$6,000
$6,000
$6,000
$6,000
$6,000
Expenses of disposition
In computing a capital gain or loss, the taxpayer may add to the ACB any outlays or expenses to the
extent that they were made or incurred for the purposes of making the disposition (40(1)(a)(i),
(b)(i)). These include certain “fixing-up” expenses, finder’s fees, commissions, surveyor’s fees,
transfer taxes and other reasonable expenses directly attributable to facilitating disposition. Fixingup expenses would include minor and incidental expenses to enhance marketability (painting or
repairing a building, even though such expenses might otherwise be current expenses and fully
deductible in the event that no sale was contemplated). Outlays to make more extensive
improvements or renovations would simply be added to the cost.
Since a deemed disposition is a concept for income tax purposes only, expense is seldom
incurred on such a disposition (although appraisal costs to establish FMV may qualify). The costs of
transferring title subsequent to a deemed disposition on death are not deductible as expenses of
deemed disposition (White Estate, 1999).
Capital losses
A taxpayer realizes a capital loss on a disposition of capital property for proceeds less than the ACB
and any expenses of disposition. Just as only one half of capital gains is taxable, only one-half of
capital losses (“allowable capital loss” or ACL) is deductible. ACL are initially deductible in the year of
disposition, to the extent of realized capital gains (CG). ABIL and unused losses on a taxpayer’s death
may be deducted against ordinary income, however. If they cannot be used up in that year, excess
capital losses are deductible in other years. Relief in the current year is called “netting.” Relief in
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54
other years is called “carry over.” The maximum period for carrying back an ACL is 3 years. The
earlier year’s loss must be deducted before a later year’s loss (111(3)(b)), and each item of loss can
be deducted only once. ACL can be carried forward indefinitely to subsequent taxation years.
A debt owing to a taxpayer for the disposition of capital property is itself a capital property.
When it becomes uncollectible, and the taxpayer so elects, the outstanding balance can be realized as
a capital loss (50(1)).
Non-recognition of capital losses (depreciable prop, PUP and LPP, superficial losses)
The ACB of a depreciable property is its capital cost. If a taxpayer disposes of a depreciable asset for
proceeds greater than capital cost, a taxable capital gain will result. A disposition for proceeds less
than capital cost does not result in an ACL (39(1)(b)), because the CCA provisions of the ITA deal
with that. (See section on CCA).
Personal-use property (PUP) is subject to two restrictions. First, a capital loss on PUP is
generally deemed to be nil, which prevents deduction of capital losses attributable to personal
consumption. (40(2)(g)(iii))—however, section 41 permits losses on listed personal property
(LPP), but losses on LPP, which are collectibles, may be deducted only from gains on LPP. Second, a
$1,000 exemption applies to dispositions of PUP (including LPP) (46(1)). Thus:
A. If the ACB is less than $1,000 but the proceeds are greater than $1,000, the gain is computed
as though the ACB were $1,000.
B. If the POD are less than $1,000 and the ACB greater than $1,000, a loss (on LPP only) is
computed as though the POD were $1,000.
C. If both the proceeds of disposition and the ACB of a property are less than $1,000, the capital
gain (or loss for LPP) is exempt.
D. If both the POD and ACB are greater than $1,000, the exemption is inapplicable and the gain
or loss computed in the ordinary way.
EXAMPLE
ACB
POD
Deemed
POD
(greater of POD
or $1,000)
Deemed
ACB
(greater of cost or
$1,000)
Capital gain (loss)
Actual gain (loss)
A
800
1,200
B (LPP only)
1,800
400
C
100
900
C2
900
200
1,200
1,000
1000
1,000
1,000
1,800
1000
1,000
200
400
(800)
(1,400)
0
800
0
(700)
As defined in section 54, PUP means capital property owned by a taxpayer and used primarily for
the personal use or enjoyment of the owner or any individual related to the owner (chattels, clothes,
personal effects, hobby assets, furniture, LPP, etc.). Certain interests in real property are PUP, such as
the family home, summer cottage or other recreational property. An option to acquire PUP or the
unpaid balance of the sale price on disposition of PUP are themselves PUP. It can be owned by
corporations, trusts or partnerships. If a taxpayer disposes of an interest in a trust or partnership, or
of shares in a corporation, and the POD are adversely affected by a decline in value of PUP owned by
it, the adverse effect is disregarded as personal expense in computing gain or loss. An asset may be
part PUP (think of a personal home with office or rental suite). An asset may be converted from PUP
to commercial or investment use and vice versa. A change in use triggers a deemed disposition
(section 45).
A debt owing to a taxpayer for the disposition of capital property is itself a capital property.
When it becomes uncollectible, and the taxpayer so elects, the outstanding balance can be realized as
a capital loss (50(1)). A debt arising out of the disposition of PUP is also PUP, and any capital loss on
the bad debt is disallowed, but it deductible to the extent of the gain reported on the disposition if it
was transacted at arm’s length (50(2)).
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If a taxpayer disposes of part of the PUP, the ACB of the part disposed of is deemed to be the
greater of the ACB as determined under subsection 43(1) or the proportion of $1,000 that the ACB of
the part disposed of bears to the ACB of the whole property (46(2)(a)). Similarly, the POD are
deemed to be the greater of proceeds or the same proportion of $1,000 (46(2)(b)).
This is susceptible to abuse if a person fragments property and alienates it in units under
$1000. In certain circumstances, subsection 46(3) deems a number of PUP, which a taxpayer
disposed of, to be one PUP and each disposal to be a part disposition. In effect, the act will join the
adjusted cost bases and the proceeds of disposition together (section 46(3)). First, the properties
must be of the type that would normally be disposed of as a set. That’s a question of fact (items
match, belong together, produced or issued at the same time, worth more collectively than
individually, etc.). That the taxpayer bought them separately is not relevant so long two or more were
concurrently owned. Second, the taxpayer must have disposed of all the items by more than one
disposition, either to one person or to the members of a group who are not at arm’s length with each
other. Third, the aggregate FMV of the assets must be more than $1,000.
Listed personal property means prints, etchings, drawings, paintings, jewellery, rare books,
stamps, and coins. The definition is exhaustive (therefore hockey cards are not listed personal
property). Section 41(2)(b) allows the taxpayer to deduct the loss retroactively for three years or up
to seven years after the loss is incurred.
Example: X sold his collection of stamps for $15,000. The stamps had been acquired by X at
various times since 1972 at a total cost of $23,000. At the same time X sold his car, which originally
cost $3,000, for $1,000, and 6 dining room chairs for $400 apiece. The chairs cost $300 each.
 What are the tax consequences?
o There is a loss of $8,000 on LPP (the stamps)
o There is a loss of $2,000 on PUP (the car), which is deemed nil
o There is a gain of $600 on PUP (the chairs), half of which will be taxed, if it’s a set. If
they do not form a set, they will be exempted.
 What if he sold the car for $4,000 instead? Then, there would be a CG of $1,000.
 What if X had sold a painting, which cost $10,000 for $15,000? Then, he’d have a gain of
$5,000 on LPP, which could apply against the $8,000 loss.
 What if the stamps were hockey cards? Then, they would be mere PUP and the los would be
deemed nil.
A superficial loss is defined in section 54 as a capital loss arising from a disposition of property if
the same or identical property or a right to acquire such property is acquired by the taxpayer—or by
a person affiliated with the taxpayer (including spouses, controlled corporations, and partnerships,
see section 251.1)—within 30 days before or after the disposition that resulted in the loss. The
superficial loss rule disallowed the loss that would otherwise result, and requires its addition to the
ACB of the “substituted property.” Recognition of the loss is postponed, therefore, to a subsequent
disposition of the substituted property. There is no superficial loss on certain deemed dispositions.
Capital gains deduction (lifetime capital gains exemption on small business corps or farm/fishing prop)
This exemption exempts up to $750,00 of capital gains on the disposition of shares of a qualifying
small business corporation or qualified farm or fishing property. That means the exemption covers
up to $375,000 of taxable CG as a cumulative lifetime total. It is available only to an individual (other
than a trust) who is a resident in Canada throughout the year. 57
Intra-family transactions (gifts and non-arm’s length transactions)
If a donor gives a capital property such as shares or land to a done, should the transfer be taxed as if
it were a sale at FMV? Generally, the ITA imposes tax on the transfer and the donor bears the tax
liability. A donor of capital property is deemed to have sold it for FMV and the done is deemed to
acquire it at an equivalent cost (69(1)(b) and (c)). The donor must compute and pay tax on a capital
gain if the FMV exceeds its ACB. If the property declined in value, then a capital loss, subject to the
superficial loss rules described above.
57
More on this at p. 583
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Realization vs. rollover treatment
In contrast to the FMV rule, rollover exempts the transfer from tax, and preserves the accrued gain or
loss until the done subsequently disposes of the property. Transfers of capital property to a
transferor’s spouse or spouse trust (and of farm property to a child) benefit from rollover treatment.
The increase or decline remains excluded from the computation of a capital gain or loss until the
done disposes of the property in a taxable transaction. To preserve any accrued and potential gain or
loss, the donee is deemed to acquire the property at a cost equal to the donor’s ACB at the time of the
transfer.58 One may opt-out of rollover treatment (see spousal transfer’s, below).
Gifts and non-arm’s-length transactions
For tax purposes, a gift is a gratuitous transfer of property. A sale at an under-valuation is not a gift
(Littler, 1978). Subsection 69(1) deals specifically with both gifts and sales. On a gift of anything, the
donor is deemed to receive POD equal to FMV and the donee is deemed to have acquired it at a cost
equal to that value. If property sold in a non-arm’s-length transactions (NALT) and the actual selling
price is greater than FMV, the proceeds to the vendor remain the selling price but the deemed cost to
the purchase is FMV. If the actual price is less than FMV, the deemed proceeds to the vendor are FMV
but the cost to the purchaser remains the actual cost. There is no explicit provision for an offsetting
correction for the other party.
A “price adjustment clause” is one whereby the parties agree to accept the ultimate
determination of FMV if it should be different from their own. If parties disagree, you can go to court
to determine it, but that will result in a battle of experts. FMV is a question of mixed fact and law
(Nash, 2006).
“Related persons” are not at arm’s length (251(1)(a)). That means:
 Individuals connected by blood relationships, marriage or adoption
o Grandparents, parents, siblings, children, successive descendants and in-laws (brother,
sister, son or daughter, grandparents, parents) — 251(6)(a) and 252(1) and (2)
o Spouse, spouses of the siblings of one’s spouse, and siblings of spouses of one’s siblings
(251(6)(b) and 252(2)).
o Since 1993, common law spouses (defined as a person living with the taxpayer in a
conjugal relationship for a least one year, or is the parent of a child with the taxpayer)
o Since 2001, same-sex partners
o Excluded are an aunt, uncle, nephew or nice, and cousin of any degree. A person is not
considered related to someone who is deceased.
 Corporations connected by common control
Unrelated persons may not deal at arm’s length as a question of fact (251(1)(c)). The following
criteria is relevant:
 The existence of a common mind that directs the bargaining for both parties to the transaction
 Parties acting in concert without separate interest (or highly inter-dependent)
 De facto control, in the sense of excessive or constant advantage, authority or influence by one
party over the other
 Price different from FMV
Spousal transfers (rollover)
Under subsection 73(1), they automatically benefit from rollover treatment unless the transferor
elects otherwise in the income tax return for the taxation year in which the transfer occurs, in which
case the general rules of 69(1) apply (subject to special rules for depreciable property under
13(7)(e)). On rollover of a capital property, the proceeds of disposition are deemed to be the ACB of
the transferred property. If the property is depreciable, the proceeds are deemed equal to the UCC,
although for the CCA provisions, the property is deemed to have a capital cost equal to its cost to the
transferor (so as to preserve the potential for recapture). The transferee is deemed to acquire the
property at the same amount so that the actual gain or loss is deferred rather than permanently
excluded.
58
For policy and reasons to elect for rollover, see p. 587
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To qualify for rollover treatment, there must be a transfer of capital property, and both
parties must be resident in Canada. The recipient must be one of the following:
 Transferor’s spouse or common law partner
 Transferor’s former spouse of common law partner, if the transfer is in settlement of rights
arising out of their marriage or common law partnership
 Spouse trust
On a marriage breakdown, the parties are still spouses before the divorce decree. Court-ordered
division of property should qualify, even if involuntary (73(1.1)).
For rules on transfer of farm or fishing property, see handbook p. 590
The family home and “change of use” rules
Gains realized on a disposition of a property that qualifies as a “principal residence” (PR), may be
exempt from tax. The exemption applies to the portion of the gain that corresponds to the period that
the dwelling qualified as a principal residence and the person was a resident in Canada—possibly,
the entire gain could be exempt (40(2)(b)). A capital loss on the disposition of an owner-occupied
dwelling is disallowed as a loss on PUP. A taxpayer may not claim CCA on the family home because it
is not held to produce income.
PR is defined in section 54 as a housing unit owned by the taxpayer and ordinarily inhabited
by him or his spouse or his children. The phrase “ordinarily inhabited” requires that it be “in most
cases, usually or commonly occupied as an abode,” and includes seasonal and recreational
occupation. If only the owner, for instance, occupies half of a duplex, only half of the land and
building comprise the principal residence. On the other hand, a house containing apartment units
may fully qualify if the division of units is internal and the occupiers share common facilities. Vacant
land does not qualify.
PR includes up to one half hectare of surrounding land that may reasonably be regarded as
contributing to the taxpayer’s use and enjoyment of the housing unit as a residence. No proof is
required for this, unless the taxpayer uses the land to earn income, but to exempt the gain on land in
excess of half a hectare, the onus is on the taxpayer to establish that it was necessary to such use and
enjoyment. The court will objectively consider all of the relevant circumstances immediately prior to
the disposition of the property, and ask whether the taxpayer has established, on a balance of
probabilities, that that the excess land no merely contributed, but was indispensable to the use and
enjoyment of the housing unit as a residence (Rode, 1985). Expert evidence is relevant, but not
conclusive. Courts have held that, if a zoning by-law imposed minimum lot sizes or forbade
subdivision into smaller parcels and these limits prevent the taxpayer from selling part of the land,
the excess is considered necessary. The critical time is the moment before disposition (Yates, 1983).
In Stuart, 2004, the court said that subjective evidence (such as the taxpayer’s lifestyle) was only
marginally relevant. Another relevant factor is accessibility to roads and utilities.
The exemption applies to only one dwelling for each taxation year. And since 1981, a family
may claim only one principal residence (that includes common law spouses since 1993, and same-sex
partners since 2001). A taxpayer may buy, renovate, occupy and sell a series of principal residences
over the years, but then the transactions risk being assessed as ACNT! The property may be located
outside Canada.59 The principal residence exemption is determined after the taxpayer has computed
the capital gain in the ordinary way. Paragraph 40(2)(b) provides a deduction from the gain based
on the number of years of ownership that the taxpayer occupied the property as his or her principal
residence. Part of a year is considered a full year.
 To calculate the exempt portion of the gain under 40(2)(b): A – (A x B/C)
o A = capital gain
o B = resident and it was your principal residence + 1
o C = number of years you owned the house
59
More detail on this, and marriage breakdown, p. 593
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Deemed disposition on change in use
Under 45(1), a disposition at FMV is deemed to occur when a taxpayer changes the use of property
from personal use to income-earning use or vice versa. A clear and unequivocal positive act
evidencing a change of intention is necessary to change the use of land (Duthie, 1995). Subsection
45(3) permits a taxpayer to elect out of the deemed disposition at FMV where a property is
converted from an income-earning use to a principal residence. The election cannot be made if CCA
has been claimed on the property for a taxation year ending after 1984 and on or before the change
in use (45(4)). In addition to the deferral of any accrued gain that would otherwise have been
realized on a deemed disposition, the election under subsection 45(3) permits the property to
qualify as the taxpayer’s principal residence for a maximum of four previous year during which it
was used for an income-earning purpose and was not occupied by the taxpayer.
Section 45(2) permits a taxpayer to elect out of the deemed disposition at FMV where
property is converted from personal-use to income-earning use. The election must be filed in year of
deemed disposition. After the change in use, CCA may not be claimed. If the taxpayer moves back into
the family home while an election is in effect, and within four years, the gain during the period that
the home was a rental property would be covered by the principal residence exemption. Even if the
taxpayer doesn’t move back in, 45(2) allows the property to qualify as PR for four more years. A
period of absence greater than four years is permissible on work relocation. In particular, a
homeowner who vacates the dwelling in order to move at least 40 kilometers closer to a new place of
employment may continue to claim the PR exemption for the property for the duration of the
relocated job plus one year or until death during the term of employment. The owner must elect to
treat the dwelling as PUP (section 54.1).
A taxpayer who has a capital asset for both income-producing and non-productive purposes
(say, a house with a home office) must allocate the cost according to the relative use for each
purpose, and do the same for the proceeds upon disposition. The taxpayer is deemed to received POD
equal to FMV of the asset multiplied by the amount of the change in use (expressed as a fraction of
the whole). The government permits a taxpayer to use a portion of the home for the purpose of
earning income without triggering a deemed disposition or losing any portion of the PR exemption so
long as:
 The income remains ancillary to the personal use
 Taxpayer does not make structural changes to the house
 Taxpayer does not claim CCA in respect of the house
Example: X acquires an asset at a cost of $4,000 intending to divide its use equally between income
production and personal consumption. When its FMV rises to $8,000 he decides to increase the
proportion of income production to 75% of its total use. Under paragraph 45(1)(c)(ii), he must
recognize a gain of:
 Deemed POD: 25% of $8,000 ($2,000)
 Deemed cost: 25% of $4,000 ($1,000)
 Deemed gain (only half taxable): $1,000 ($500 taxable)
Identical properties (s. 47)
Finally, to compute the ACB when identical property is sold (like shares), the taxpayer must take the
weighted average of the costs to acquire the property. Consider the following example: a taxpayer
acquires 20 shares in X Co. in 2002, 2003, and 2004, paying $8, $10, and $15 per share respectively. If
in 2005 X sells 10 shares for $20, the capital gain is calculated as follows:
 ACB = total cost multiplied by the number of identical items sold / total of identical items
o ACB = ($8 x 20 + $10 x 20 + $15 x 20) x 10 / 60
o ACB = $110
 In 2005, he sold for shares for $200, so the capital gain would therefore be $90.
SUBDIVISION E DEDUCTIONS
Subdivision e allows for certain personal expenses or investments to be deducted (RRSPs, spousal
support payments, moving expenses, child care expenses, etc.). Section 3 makes subdivision e
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deductions available only to the extent that the amount they cover have not already been deducted
some other way. Section 62 recognizes a deduction for defined moving expenses, limited to the extant
that the individual earns employment or business income at the new location. It also provides a
similar deduction for full-time students to the extent that their income includes a bursary,
scholarship or research grant.60
Section 63 provides a measure of tax relief for a parent who must pay childcare expense in order
to earn income from employment or business. The deduction must be taken by the lowest-earning
spouse. Section 63 has several limitations:
 It is only available to reduce “earned income”
 It cannot exceed 2/3 of the income of the individual claiming it
 It is capped at $7,000 per child under the age of 7, and $4,000 per child between 7-16
Childcare expenses include babysitting, day nursery services, day-care centers, fees paid to an
educational institution for non-educational childcare services, day camps, and attendance at
boarding schools. Paragraph 63(3)(d) excludes medical expenses, clothing, transportation,
education, lodging.61
In Levine, 1995, the court compared the English expression “child care” with the French
version of the text: “frais de garde d’enfants.” It noted that, within the meaning of 63(3)(a), child care
expenses are those which are incurred for the purpose of watching over the children to protect them
while the parents are away, therefore allowing parents to earn income. Thus, the court refused to
allow deductions for ballet lessons, ski school fees, gymnastics, skating, swimming, etc., because
these were incurred primarily to develop the physical, social and artistic abilities of the children, and
were expenses that would have been incurred whether or not the parents had been working. While it
is true that whoever gave these children lessons also watched over them, the court noted that “this
person’s primary role is not to watch over the children, but to teach them ballet, swimming, skating,
arts, etc.”62
In Symes, 1994, a lawyer claimed salary paid to her childcare provider as business income
deduction, arguing that current social and economic realities of women in the work force made child
care expenses a legitimate business expense under paragraphs 18(1)(a) and (h). She further argued
denial of such a deduction was discriminatory under section 15 of the Charter. The court pointed out
that s. 63 captured the purpose for which the appellant incurred her nanny expenses, and that since
s. 63 was “really a code in itself, complete and independent,” it was under this detailed provision, and
not the more general section 9 and subsections 18(1)(a) and (h), that the court should assess the
payments. It noted that s. 63 was intended to limit childcare expense deductions to lower-earning
spouses, which was not the case of Symes. It also pointed to section 4(2), which said that “no
deductions permitted by sections 60 to 63 are applicable either wholly or in part to a particular
source,” which the court interpreted to mean that such deductions cannot occur within the source
calculations (see section 3), which in turn means that “child care cannot be considered deductible
under principles of income tax law applicable to business deductions.” The court also dismissed the
Charter challenge, although we are not provided much detail as their reasoning there. There was a
strong dissent by L’Heureux-Dubé, which deplored that “the definition of a business expense under
the Act has evolved in a manner that has failed to recognize the reality of business women.” 63
Prior to April 1997, alimony or maintenance payments for the support of a spouse or child
were deductible under paragraph 60(b) and were included in the recipient’s income under
paragraph 56(1)(b). Since April 30, 1997, only payments that are clearly designated as spousal
support are within the deduction-inclusion regime—child support payments are just deductible.64
For more detail, see handbook p. 613-617
See handbook p. 618 for more detail
62 For more examples of expenses allowed/disallowed + criticism on s. 63, see handbook p. 623-625
63 For excerpts of the dissent, see handbook p. 628
64 For more detail re child/spousal support payments, see handbook p. 629-631
60
61
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CALCULATION OF TAXABLE INCOME (OVERVIEW)
In calculating their tax liability, taxpayers first determine their net income for tax purposes. The rules
for calculating net income are contained in Division B of Part I of the Act. Although there is no formal
definition of gross or net income, section 3 provides a formula for calculating net income for tax
purposes. Very basically, it contemplates the following steps. First, the taxpayer “determines the total
of all amounts each of which is the taxpayer’s income for the year [other than capital gain] from a
source inside or outside Canada, including, without restricting the generality of the foregoing, the
taxpayer’s income for the year from each office, employment, business and property.” Second, they
add their net taxable capital gains. Third, they subtract the deductions permitted in subdivision e.
Fourth, they subtract any losses from employment, business, and property. All income or losses are
net ones.
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SECTION 3 I.T.A.
PAR. # SUB.
PAR #
NATURE OF INCOME INCLUSION (DEDUCTION)
TOTAL
ADD all income except TCG:
(a)
-
employment
business
property
“other” [i.e. s. 56 to 59 and generic sources]
ADD the amount by which (i) exceeds (ii) [can’t be negative figure]
(i)
the total of:
(b)
(A) TCG, excluding LPP
(B) taxable net gain from LPP, that is, amount
by which TCG from LPP exceeds ACL from
LPP in yr, 7 previous yrs or next 3 yrs [s. 41 can’t result in negative figure]1
(ii)
ACL, excluding ACL from LPP and ABIL2
(c)
SUBTRACT “other” deductions in subdivision (e)[i.e. s. 60 to 66.7] but not
exceeding (a) plus (b) [i.e can’t result in negative figure]3
(d)
SUBTRACT the following but not exceeding the amount by which (a) plus
(b) exceeds (c) [i.e can’t result in negative figure]4
-
(e)/(f)
1
2
3
4
5
loss from employment
loss from business
loss from property
ABIL5
INCOME FOR TAX PURPOSES [can’t be negative figure]
If ACL on LPP exceeds TCG on LPP it is called a “listed-personal-property loss”, which can be carried back 3
yrs or forward 7 yrs to deduct only against TCG on LPP in those yrs [ ss. 41(3) definition of “listed-personalproperty loss” and ss. 41(3) computation of taxable net gain from LPP].
If ACL, excluding ACL from LPP and ABIL, exceeds the sum of TCG and taxable net gains on LPP, the excess
is called a “net capital loss” and can be carried forward indefinitely (except in the case of a corporation where it
stops being available upon a change of control of the corporation) or back 3 yrs to deduct only against TCG in
those yrs (exception in year of death and preceding year) [par. 111(1)(b)]. Note: the deduction of net capital
losses carried forward or back is taken in the computation of “taxable income” under s. 111, that is, after income
for tax purposes has been computed under s. 3; the deduction of net capital losses carried forward or back is not,
therefore, provided for in s. 3.
Unless the specific terms of the provision allow for a carryover of any excess, generally speaking, the amount of
any excess of such deductions over other income for the year is not available to be carried forward or back.
If these losses exceed the rest of the income for the year, the excess is called “non capital loss” and can be
carried forward 20 yrs and back 3 yrs to deduct against income from all sources, subject to certain limitations in
the case of change of control of corporations [par. 111(1)(a)]. As with net capital losses, the deduction of non
capital losses occurs in the computation of “taxable income” under s. 111, that is, after income for tax purposes
has been computed under s. 3. As such, the deduction of non capital losses is not provided for in s. 3.
If any ABIL exceeds the other income of the year, it is included in non capital losses and dealt with as described
in the preceding footnote. If it has not been completely used after 20 yrs, it “reverts” to being treated like an
ordinary ACL and is included in net capital losses to be dealt with as described in footnote 2.
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Example of application of s. 3 I.T.A.
Taxpayer earns (loses) as follows:
-
salary from employment
-
deductible expenses incurred to earn salary
-
revenues from a business on the side
15,000.00
-
deductible expenses incurred to earn revenues from
business
(20,000.00)
-
received support amount solely for spouse [56(1)(b)]
12,000.00
-
paid out child care expenses, of which deductible portion is
-
the following capital gains or (capital losses):
- CG on sale of gold bars
- CL on sale of pleasure boat
- CL on sale of stamp collection
- CG on sale of jewelry
- CL on sale of shares of public company
- CG on sale of vintage automobile
- Business Investment Loss
$ 50,000.00
(10,000.00)
(16,000.00)
16,000.00
(10,000.00)
(40,000.00)
8,000.00
(6,000.00)
14,000.00
(24,000.00)
1. Calculate income for tax purposes for the year under s. 3 (see verso).
2. List and describe nature of and rules for deductibility of any losses from the year available to
be carried forward or back in computing taxable income for other years.
In the above example, the calculation of income for tax purposes would go like this:
a) ADD all income except TCG: $52,000
— Income of $40,000 from employment (salary minus expenses incurred to earn it)
— No business income (expenses incurred for business outweigh revenues)
— No income from property (no revenue or expense listed)
— Income of $12,000 from other sources (spousal support)
b) ADD the amount by which (i) exceeds (ii) [can’t be negative figure]: $12,000 (so we are now
are $64,000)
i.
Total of A + B:
A. TCG, excluding LPP: $15,000
— $8,000 from the gold bars
— $7,000 from the car
B. Taxable net gain from LPP: nil
— $40,000 loss from the stamps
— $8,000 gain from the jewelry
— In total a loss of $32,000, so an ACL of $16,000 from LPP
ii.
ACL (excluding ACL from LPP and ABIL): $3,000
— Nil loss from the pleasure boat because it is a PUP
— Loss of $3,000 from the shares
c) SUBTRACT “other” deductions in subdivision (e) [i.e. s. 60 to 66.7] but not exceeding (a)
plus (b) [i.e can’t result in negative figure]: $16,000 (so we are now at $48,000)
— $16,000 from deductible childcare expenses
d) SUBTRACT the following but not exceeding the amount by which (a) plus (b) exceeds (c) [i.e
can’t result in negative figure]: $17,000 (so we are now at $31,000)
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— No loss from employment
— $5,000 loss from business
— No loss from property
— $12,000 ABIL
e) INCOME FOR TAX PURPOSES [can’t be negative figure]: $31,000
Now, what about the ACL of $16,000 from LPP? It can’t be used this year, but can be carried forward
or backward (see s. 41).
FROM NET INCOME TO TAX
Tax payable is calculated by applying the relevant tax rates to taxable income and then reducing this
amount by any available tax credits. Subsection 2(2) defines a taxpayer’s taxable income as his or
her income for the year under section 3, plus the additions and minus the deductions permitted by
sections 100 to 113.
Carry-over of losses
The loss carryover provisions provide the more significant taxable income deductions. To the extent
that current year losses cannot be used in the year that they arise (section 3 does not permit a
negative balance), the losses may be carried over to another year (either forward or backward) and
deducted in the calculation of taxable income for that other year.
Paragraph 111(1)(a) permits the deduction of non-capital losses—which includes a loss
from business or employment (see subsection 111(8) for the definition of non-CL)—over a 23-year
period: that is, three taxation years before the loss was incurred and the 20 subsequent taxation
years. There is generally no restriction on the source of income that these losses can be used to offset.
Subsection 111(5) to (5.4) and 249(4) have been enacted to limit a perceived abuse of the noncapital loss carry-forward provisions where taxpayers who purchase corporations with undeducted
losses realized in previous years transfer a business to it and use said losses to reduce the future
profits from the business. Thus, the general rule is that, where there has been no change in control,
non-capital losses may be deducted from all sources of income. Where, however, control is acquired
by another person, the corporation’s taxation year is deemed to end immediately before the
acquisition of control, and losses realized in that year or a previous year cease to be deductible unless
the corporation continues to carry on the loss business with a reasonable expectation of profit, in
which case the losses are deductible only against income from the business. Similar restrictions apply
to certain other types of accrued but undeducted losses.65 There is also a special set of rules for “farm
losses” and “restricted farm losses.”66
Net Capital Losses, as defined in subsection 111(8), may be carried back three years and
forward indefinitely, but are deductible only from taxable capital gains (111(1)). Net capital losses
that could not be used because the taxpayer did not have enough gains to offset may therefore carry
over. Where control of a corporation is acquired, the net capital losses of the corporation are not
deductible (111(4)). ABIL also have special rules: they can be carried over three years back, and
forward indefinitely, and applied against any source of income—but after 20 years they can only be
used to reduce CG instead of any source (essentially, they become like a net capital loss).
Tax credits
Tax credits are calculated by multiplying a base amount by a percentage defined in subsection
248(1) as the lowest tax bracket in subsection 117(1)—in 2010, that means 15%. The credit is then
subtracted from the initial calculation of federal tax to arrive at federal tax payable. Most credits are
non-refundable, which means that if a taxpayer’s income is so low that they owe no taxes, or very
little, they get little or no value from the credits (i.e., the government will not send them a cheque).
65
66
For examples, see handbook p. 103, but there is little detail
See handbook p. 103
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Charitable donations
Individual donors to registered charities and government entities receive a non-refundable tax credit
under section 118.1. The first $200 of the donor’s total eligible donations for the year are calculated
using the 15% lowest marginal tax rate, and the balance at the 29% highest marginal rate. Gifts in
kind are receipted based on fair market value. The government does not recognize a gift of services
(IT-110R3). For the purposes of 118.1, a payment may be in part gift and in part payment for
services. With the exception of crown gifts, cultural gifts, and ecological gifts, charitable donations
may not exceed an annual limit of 75% of the donor’s income for the year. The unused portion of a
charitable donation can be carried forward 5 years, at which point any unused amounts expire.
Donations of capital property, such as land, trigger a deemed disposition, which can results in the
realization of taxable capital gains under paragraph 69(1)(b). In Olympia, 1970, it was confirmed
that a taxpayer would be able to deduct charitable donations as a business expense if it can be
established that the donations were made for an income-earning purpose. Of course, the taxpayer
must then choose either to deduct the amount as a business expense or claim the tax credit.
In McBurney, 1985, the taxpayer paid certain amounts to some religious schools that were
attended by his children. The school were non-profit and registered charities. Parents were expected
to make financial contributions, but not legally obligated. McBurney deducted his contribution as
charitable donations, but the government assessed them as payments on account of tuition fees and
disallowed the deduction. The court sided with the government. The court elaborated on what a “gift”
is, at least for tax purposes: a gift is nearly always property transferred voluntarily (although if done
under a legally binding promise, it might still constitute a gift), and there is nearly always no quid pro
quo (although a valuable return may not prove conclusively that there was no gift). Even though
McBurney was under no legal obligation to contribute, the payments were not gifts, the court said,
because the “securing of the kind of education [McBurney] desired for his children and the making of
the payments went hand-in-hand.” The payments were directly related to the presence of his
children at this school, and grew out of a sense of personal obligation to ensure that his children
would receive a Christian education, which McBurney viewed as a return for the payments. In other
words, there was a quid pro quo. This is further evidenced by the fact that McBurney stopped
contributing once the children left these schools.
In Klotz, 2004, the taxpayer was involved in a “buy low, donate high” scheme where artwork
were purchased at a very low price, then valuated with a FMV at a higher price ($1,000) and donated,
so that Klotz could claim a large tax credit even though he had actually spent much less. Even though
it was acquired only to be disposed of, the artwork was considered PUP (the court said the court:
“one way of using an object is to give it away, whether the motive be altruistic, charitable or fiscal”).
Thus paragraph 46(1)(a) bumped its cost-base to $1,000 and therefore the $1000 FMV valuation
meant that no capital gain was generated by the donation—and therefore not tax to pay, only a tax
credit to claim (see section on PUP). But the court then noted that while the “intent or expectation of
obtaining a tax advantage does not vitiate the charitable gift,” nonetheless “the [taxpayer] in such
circumstances runs a risk that [the court] may conclude that the best evidence of fair market value is
the price at which the object was bought.” Accordingly, the FMV was decreased and the tax credit
with it.67
Medical Expenses
The Medical Expense Tax Credit is a non-refundable credit for a broad range of medical and
disability-related expenses. Expenses can be claimed when they exceed a threshold of 3% of a
taxpayer’s net income or an inflation-adjusted amount of $2,024—whichever is less. Expenses for
one’s spouse or children can be included. Expenses can be claimed for any 12-month period ending in
the taxation year (and 24 months in the year of death). There is also a supplement for adult lowincome earners.68 METC claims must be supported by receipts. There is no limit to the amount that
can be claimed. Subsection 118.2(2), which is interpreted restrictively by courts (see below),
describes qualifying expenses. These expenses include: payments to hospitals and health
67
68
This case also talks about penalties for gross negligence in tax law. See handbook p. 647
See handbook p. 650 for more detail and policy considerations surrounding METC
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professionals; devices such as prosthetic limbs, hearing airs, prescription eye glasses, and oxygen;
full-time care either in a nursing home care or in the patient’s home; home renovations for disabled
patients; prescription drugs and private health insurance premiums; gluten-free food for persons
with celiac disease; organ transplant costs; and animals trained to assist persons with restricted use
of their arms and legs…
In Whitfield, 2005, the taxpayer who had serious medical problems purchased an elliptical
trainer, because his orthopedic surgeon recommended “no impact” exercise, and a hot tub, because
his psychiatrist recommended hydrotherapy. Subsection 118.2(2) reads in part:
[…]
(2) For the purposes of section (1), a medical expense of an individual is an amount paid
[…]
(m) For any device or equipment for use by the patient that
i.
Is of a prescribed kind,
ii.
Is prescribed by a medical practitioner,
iii.
Is not described in any other paragraph of this subsection, and
iv.
Meets such conditions as may be prescribed as to its use or the reason for its acquisition
To the extent that the amount so paid does not exceed the amount, if any, prescribed in respect of the device or
equipment
Further, section 5700 of the Income Tax Regulations informs us that for the purposes of paragraph
118.2(2)(m), a device or equipment is prescribed […] when is it designed to assist an individual in
walking where the individual has a mobility impairment. The court acknowledged that “where a
physician ‘prescribes’ something it need not be in writing,” but found that the doctors had prescribed
non-impact exercise and hydrotherapy, not an elliptical trainer and a hot tub. That is, they never
mentioned a specific device. Because a hot tub is really the best way to obtain hydrotherapy,
however, the court found that it had been prescribed, but refused to recognize the elliptical trainer.
The court then moved on to the question of whether the hot tub was “of a prescribed kind.” It noted
that jurisprudence was inconsistent, but that generally “if on the evidence the judge finds that a
significant purpose and use of the [device or equipment, in this case a hot tub,] is to assist in the
mobility of the individual the courts seem inclined to allow the expense.” Yet, the court found that
“neither the hot tub nor the elliptical trainer were designed to assist the individual in walking,
though they may have helped to alleviate the hip and back pain and the hot tub certainly alleviates
the depression.” Therefore, the court did not allow the deductions for either device. Another thing to
remember from Whitfield is that case law is generally inconsistent as to what qualifies as a medical
expense.
Subsection 118.4(2) allows for naturopathic services if the naturopath is licensed as a
medical practitioner in the province in which he practices (possible only in BC, Sask., Man., Ont., and
N-S). Paragraph 118.2(2)(n) specifically requires that over-the-counter medicine or specialized
foods be recorded by a pharmacist in order to be claimed as a medical expense. In Lang, 2009, the
court allowed a portion of private school tuition fees to be claimed as a medical expense. The
taxpayer relied on subsection 118.2(2)(1.91), which allows for remuneration of tutoring services.
Tuition and education
There are four separate credits that students can claim in relation to education:
1. Tuition fees (section 118.5)
2. An education amount (subsection 118.6(2))
3. A textbook amount (subsection 118.6(2.1))
4. Interest on student loans (section 118.62)
Subparagraph 118.5(1)(a)(ii) sets out to met in order to be able to claim the tuition and education
tax credits: first, the individual must be a student enrolled at an education institution in Canada;
second, that educational institution must be a university, college or other educational institution
recognized by Human Resources and Skills Development Canada; third, it must provide courses at a
post-secondary school level. The full amount for tuition is eligible. The education and textbook
credits are calculated based on the number of months in school multiplied by a set amount that
varies for full- and part-time studies. The student loan interest credit applies to interest paid on
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Summary by Pascal Archambault-Bouffard for Allard’s Fall 2010 Taxation course
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federally or provincially sponsored loans.69 Subsection 118.5(3) excludes from tuition fees amounts
paid for student association fees, charges for services that are not normally provided at Canadian
post-secondary educational institutions (e.g., campus gym membership), and property to be acquired
by a student (e.g., a laptop or tool specific to the trade). A student may carry forward unused credits
to future taxation years. Alternatively, up to $5,000 of the amount on which the credit is based can be
transferred to a spouse, common law partner, parents, or grandparents.
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For policy underlying these credits, see handbook p. 666
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