Canada, tax, TaxBreaks, December 2005 newsletter

TaxBreaks, December 2005 (05-6)

New U.S. independence rules may affect you
RRSPs: Beware of promoters of questionable schemes
How to Reduce the Tax You Pay: New Edition
Tax measures taking effect on January 1, 2006
Did you know that . . .

New U.S. independence rules may affect you

Many senior executives have engaged the same accounting firm that audits the company for which they work to provide personal tax services. Such services range from annual tax return preparation to more extensive personal tax and estate planning.

On July 26, 2005, the Public Company Accounting Oversight Board (PCAOB) in the United States adopted ethics and independence rules to govern the provision of certain tax services to Securities Exchange Commission (SEC) registered audit clients of accounting firms. The rules are expected to be approved by the SEC in mid-January 2006. Upon the approval of these rules, certain tax services offered by the company’s audit firm to its senior executives may be prohibited.

Tax services for persons in financial reporting oversight roles
PCAOB Rule 3523 states that a public accounting firm is not independent of an audit client in situations where, during the audit period, it also provides tax services to an individual or immediate family member of an individual who is in a “financial reporting oversight role”.

A person in a financial reporting oversight role is any person who has direct responsibility for, or oversight over, those who prepare documents filed with the SEC. Examples of such documents include financial statements, related information and management’s discussion and analysis. Immediate family members are defined to include a spouse, spousal equivalent and dependants of the employee.

The following list, although not exhaustive, provides examples of persons in a financial reporting oversight role: President, CEO, CFO, COO, CAO, General Counsel, Controller, Director of Internal Audit, Director of Financial Reporting, Treasurer, or equivalent.

Tax services cannot be provided to these persons or their immediate family members, subject to certain exceptions described below. These services cannot be provided, regardless of whether the company pays for them, or reimburses the cost, or the executive incurs the cost personally.

Permitted exceptions
There are several exceptions to the general rules. The intent of these exceptions is to exclude individuals who do not influence the consolidated financial statements of an audit client. A transition period is also permitted in certain situations.

Independent (non-executive) directors of an entity’s board are not impacted by the rules.

In addition, employees in a financial reporting oversight role at an affiliate are excepted where the affiliate is immaterial to the SEC registrant or the affiliate is audited by a firm other than the firm, or an associated person of the firm, which audits the SEC registrant.

There is a transition rule for situations where tax services are being provided pursuant to an engagement already in process at the time the rules are approved, provided that the services are completed on or before the later of June 30, 2006, or ten days after the date that the SEC approves the rules. An engagement will be considered in process if an engagement letter has been executed and work of substance has commenced.

In situations where an individual was hired or promoted into a financial reporting oversight role at an SEC registered audit client, the rules state that tax services may be provided pursuant to an engagement already in process before the change in employment event and the services are completed within 180 days of the particular event.

Executives who are covered by the PCAOB rules will be permitted to seek the assistance of the audit firm which prepared their tax return prior to the implementation of these rules in responding to an examination of that tax return by the taxation authorities. For example, the rules would permit the audit firm to respond to an assessment notice related to a tax return prepared by the audit firm in a previous taxation year. Such assistance must remain consistent with general independence rules, which provide that the audit firm must not act as an advocate for its audit client as may occur if a situation proceeds to litigation.

The rules permit tax services to be provided to entities that are controlled by individuals in a financial reporting oversight role, such as a trust, investment holding company, or partnership. However, in practice it may be difficult to separate the tax services provided to a related entity from the tax services provided to the individual executive, which are prohibited by the PCAOB rules. Therefore, it is strongly recommended that the audit committee be notified in advance of providing tax services to an entity controlled by an individual with financial reporting oversight responsibilities to ensure that the PCAOB rules are met and any other independence rules are addressed.

What affected executives need to do
The SEC is expected to approve the rules by mid-January, 2006. As a result of these rules, certain executives may be required to terminate long-standing relationships with their tax providers. Given that personal tax returns are due in April, executives should determine whether they are affected by these rules now to ease the transition to a new service provider.

As a senior executive, you must first determine whether you are in a financial reporting oversight role, if you have not already been advised that you are by your employer. You will need to contact the appropriate person within your company and, in some situations, the PCAOB, to make this determination. Following a positive determination, you will need to determine whether any of the exceptions apply to your specific situation. If not, you should make arrangements to transition the work to a different service provider.

Sharon Paterson, Toronto

RRSPs: Beware of promoters of questionable schemes

The Canada Revenue Agency (CRA) recently alerted taxpayers about schemes offered by unscrupulous promoters, promising a tax-free withdrawal of registered retirement savings plan (RRSP) funds (see the CRA Web site for a Taxpayer Alert on the subject).

The CRA reminds taxpayers that such schemes could produce unsettling results. It cites a recent decision by the Tax Court of Canada (Dubuc v. The Queen) in which a taxpayer was swindled by the promoter of such a scheme. The appellant alleged that she trusted the promoter because the promoter’s business seemed “professional, trustworthy, and serious.” Furthermore, she had obtained confirmation from a representative of the tax authorities that such a transaction was indeed possible.

Judge Tardif of the Tax Court of Canada did not question the taxpayer’s good faith, even though it was impossible to identify the representative of the tax authorities or to determine accurately what that representative actually said. The judge ruled, however, that the fact that a tax official provides a taxpayer with an erroneous interpretation, even if this is proven, does not constitute a valid reason for cancelling a tax assessment under the Income Tax Act.

In the case, Ms. Dubuc had purchased shares of a private company for approximately $20,000 with the money from her self-directed RRSP. Following the acquisition, a company related to this private company provided a loan to Ms. Dubuc in the amount of $16,620, less fees totalling more than $3,000. Furthermore, the loan was secured against her RRSP. It seems that she never intended to reimburse this loan, convinced that if she did not pay it back, the loan would be reimbursed by her RRSP.

Following an audit, the CRA issued an assessment whereby it added an amount of approximately $20,000 to Ms. Dubuc’s taxable income. The Tax Court of Canada then confirmed this assessment. According to the CRA, the shares purchased using the RRSP were not qualified investments and, consequently, the value of the shares had to be added to Ms. Dubuc’s taxable income. Also, if a holder uses an RRSP as security for a loan, the value of the RRSP has to be added to the taxpayer’s taxable income.

To avoid becoming a victim of such schemes, taxpayers must be very cautious, recommends the CRA, as promoters attempt to swindle those who are less knowledgeable.

It is worth mentioning that in special circumstances, one can make a tax-free withdrawal from an RRSP (that is not locked in) under certain conditions and according to the following programs: (a) the Home Buyers’ Plan, to buy or build your first home or a dwelling for a disabled person related to you; (b) the Lifelong Learning Plan, to finance training or education for you, or your spouse or common-law partner.

Michel Ostiguy, Montréal

How to Reduce the Tax You Pay: New Edition

Do you want to save taxes for 2005 and implement effective tax planning throughout 2006? If so, you should obtain a copy of the 18th edition of How to Reduce the Tax You Pay, written by members of our firm. With over 380,000 copies in print, this popular annual book, published by Key Porter Books Limited, will be available in or through bookstores across Canada in January 2006 for $19.95 a copy, or order from Chapters Indigo Online.

Tax measures taking effect on January 1, 2006

In Québec
Certain measures announced in the Québec budget of April 21, 2005, affecting both businesses and individuals, will take effect on January 1, 2006. With respect to businesses, note that when a business’s taxation year overlaps January 1, 2006, an allocation based on the number of days applicable to each period must be carried out. Among the new measures for businesses are the following:

The corporate tax rate applicable to active business income will increase, going from 8.9% to 9.9%. The combined federal and provincial rate will therefore rise from 31.0% to 32.0%.
However, the corporate tax rate applicable to the first $400,000 of business income eligible for the small-business deduction earned by a Canadian-controlled private corporation (CCPC) will decrease, going from 8.9% to 8.5%.
The rate of capital tax will be reduced from 0.6% to 0.525% for corporations that are not financial institutions. The rate of capital tax for financial institutions will be reduced, falling from 1.2% to 1.05%.

Regarding individuals, the following measures will also come into force next January 1:

A new tax deduction equal to 6% of earned income for the year, up to $500, will be introduced.
A new, refundable tax credit will be introduced for natural caregivers of housed adults, up to a maximum of $1,000 per year. The credit will be reduced to a minimum of $550 if the income of the housed person exceeds $20,000. This new credit will replace the non-refundable tax credits for a dependant with an infirmity and the tax credit related to the transfer of the unused portion of the tax credit for severe and prolonged mental or physical impairment. It will also replace the refundable tax credit for an adult housing a parent.
The new Québec parental insurance plan will replace the payments that Québec residents receive under the Employment Insurance Act with similar payments, since, as of January 1, 2006, parental, maternity and adoption payments will no longer be administered by the federal government, but by the government of Québec. Following the implementation of this new plan, employees (and employers) will have to pay a new contribution; however, contributions to the Employment Insurance Plan will be reduced.

The Québec Minister of Finance recently announced that an indexation of 2.4% will be applied on the tax table and tax credits for individuals as of January 1, 2006.

Furthermore, certain measures that already exist will be improved:

The amount used to calculate the tax credit for severe and prolonged mental or physical impairment will change from $2,200 to $2,250.
The supplement for parents with a handicapped child under the age of 18 years will be raised by $37.50 per month, which represents an increase of $450 per year.

Federal measures
Before the dissolution of Parliament, the federal government proposed new tax measures in its budget of February 23, 2005, as well as in its Economic and Fiscal Update of November 14, 2005.

The proposed changes in the February 23 budget that were to have applied on January 1, 2006, are:

The contribution limit applicable to money purchase Registered Pension Plans (RPPs) is increased to $19,000. A corresponding increase applies to the money purchase contribution limit for defined benefit RPPs and deferred profit-sharing plans.
The RRSP contribution limit increases to $18,000.

Certain measures were accelerated by the Economic and Fiscal Update of November 14, 2005, and new measures were announced that concern both businesses and individuals. Listed below are some of those measures:

Elimination of the capital tax on corporations is accelerated to January 1, 2006.
The carry forward period for non-capital losses and investment tax credits is extended to 20 years for the losses incurred and credits earned in tax years ending after 2005.
The tax rate applicable to the low bracket of personal income decreases from 16% to 15% retroactive to January 1, 2005.
Increases in the basic personal amount ($8,148 in 2005) and that in respect of a spouse or common-law partner (maximum of $6,919 in 2005) were accelerated and raised by $500 and $425 respectively, retroactive to January 1, 2005. Indexing will be added to these increases.
As of 2006, the Child Disability Benefit increases to $2,300, and the refundable medical expense supplement increases to $1,000.

In light of the current political situation, the adoption and the effective date of the announced measures remain uncertain; to be adopted, these measures will have to be tabled once again in the House of Commons following the upcoming federal election.

Did you know that . . .

Changing the tax treatment of certain expenses. On November 17, the federal Minister of Finance proposed a change (now on hold pending the federal election) to the income tax treatment of certain expenses. Accordingly, a taxpayer will not be considered to have made an expenditure upon which a tax credit or deduction may be claimed, except to the extent that the amount is actually disbursed by the taxpayer. This change is intended to counteract the February 2005 decision of the Tax Court of Canada in the Alcatel case, which allowed the corporate taxpayer to claim a scientific research and experimental development tax credit for the amount by which the fair market value of shares issued by the corporation exceeded the exercise price payable to the corporation for its shares under an employee stock option plan. For further information, see the December issue of our R&D Tax Update newsletter on our Web site.
Maximum CPP contributions to rise in 2006. The maximum contribution to the Canada Pension Plan (CPP) by an employer and an employee will increase by $49.50 to $1,910.70 in 2006, while the maximum self-employed contribution will increase by $99 to $3,821.40.
Employment insurance premiums reduced. Effective January 1, 2006, a reduction in the employment insurance (EI) premium rate will bring the rate outside Quebec for employees to $1.87 per $100 of insurable earnings, down from the current $1.95. The comparable rate for employers will be $2.62, down from $2.73 this year. Maximum insurable earnings will remain at $39,000. As a result, maximum annual premiums in 2006 outside Quebec will be $729 by an employee and $1,021 by an employer. Lower EI rates of $1.53 for employees and $2.14 for employers will apply in Quebec, where both employees and employers will be required to contribute to the new Quebec Parental Insurance Plan, effective January 1, 2006.)
Be a wise donor. Individuals and businesses are constantly being asked to make donations to various charitable organizations. Before making a donation, be sure you are well-informed. Only charitable organizations that are registered under the Income Tax Act are permitted to issue official receipts for donations. Registration can be verified on the Web site of the Canada Revenue Agency. The Agency also reminded taxpayers recently to be careful about certain strategies used by unscrupulous promoters, including tax shelter donation schemes
Prescribed interest rates for the first quarter of 2006. The prescribed interest rates that will apply for income tax purposes for the first quarter of 2006 will remain unchanged. The rates that will be in effect from January 1 to March 31, 2006 are: 7% on overdue taxes, Canada Pension Plan contributions and Employment Insurance premiums; 5% on overpayments; 3% on taxable benefits for employees and shareholders from interest-free or low-interest loans.

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