TaxBreaks, February 2004
As the information slips and the other bits and pieces of information you need to complete your 2003 tax returns start to come in, you are no doubt beginning to wonder if there are any details you should pay special attention to when filing your returns this year. Without hesitation we would reply that yes, there are. Several changes made in 2003 should be considered, and there are other matters that are always worth reviewing before we begin this annual chore.
Filing tax returns
To benefit from the Canada Child Tax Benefit (federal), Québec family allowances and similar programs offered in most of the other Canadian provinces, both spouses must file an income tax return, even if one of them has no income. The same goes for taxpayers wishing to claim the federal GST/HST tax credit or the Québec QST tax credit. If you are a student and want to carry forward tuition fees that you were not able to claim in 2003, you should file Schedule 11 with your federal return and Schedule M with your Québec return so that the tax authorities can track these amounts.
Indexation and other changes
Several years ago the federal and Québec governments reintroduced indexation of tax brackets and personal credits. Taxpayers will therefore see a slight increase in these brackets for 2003 at the federal level and in Québec, as well as in British Columbia, Ontario and New Brunswick.
In Saskatchewan, the entry level for the second tax bracket went from $30,000 to $35,000, and the third rose from $60,000 to $100,000. Tax rates for various brackets of taxable income remain unchanged in all provinces except Saskatchewan, where they fell respectively from 11.25%, 13.25% and 15.5% to 11%, 13% and 15%.
New Brunswick rolled back its dividend tax credit from 7.6% to 3.7%. Ontario’s equity in education tax credit, first offered in 2002, was eliminated.
Change in the definition of common-law partner
Under current tax laws, a common-law partner is defined as a person, of the opposite sex or of the same sex, who cohabits with you in a conjugal relationship and meets one of the following conditions:
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He or she is the parent of your child or has adopted your child, legally.
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He or she has been cohabiting with you in a conjugal relationship on an uninterrupted basis for at least 12 months.
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He or she has already cohabited with you as your spouse or in a conjugal relationship on an uninterrupted basis for at least 12 months.
According to the proposed change, the last condition will no longer apply. The result of the change will be that someone (other than the father or mother of your child) will become your common-law partner only after your current relationship with this person has continued on an uninterrupted basis for at least 12 months. This change will apply to the 2001 tax year and thereafter once it becomes law, both for federal and provincial income tax purposes.
Mutual funds and income trusts
If you have mutual funds or income trusts in your non-RRSP portfolio, pay particular attention to your calculation of the adjusted cost base (ACB) of these financial instruments. To avoid double taxation, the ACB of a mutual fund or income trust must be increased by the amount of periodic income distributed as units. Furthermore, the amounts you periodically receive from income trusts often include the payment of a capital sum which must be deducted from the ACB. By taking these adjustments into account, you can correctly calculate the capital gains or losses when you sell these investments.
Foreign mutual funds and other foreign investments
If you hold investments in foreign mutual funds or interests in other foreign investments, you must determine if you are subject to the new rules concerning foreign investment entities (FIE). The final version of these new rules was released October 30, 2003, and they came into force as at January 1, 2003. The purpose of the new rules is to put an end to the particular benefits enjoyed by Canadians holding foreign mutual funds which were not available to those holding Canadian mutual funds.
FIE rules are complex and cannot be summarized in a few sentences. For more information, please refer to the Executive TaxBreaks, Winter 2004 newsletter. We advise you to consult a tax expert to find out whether your interests in foreign mutual funds or other foreign investments are FIEs and if they are subject to the new rules. You may also need to know the amount to be added to your income for 2003.
Do you have net capital losses?
First, you need to determine if your total losses upon disposing of investments and other property in 2003 exceed your capital gains. If they do not, you will have realized a lower net capital gain because of such losses, and half the net gain is taxable. If, on the other hand, the total amount of your losses is greater than your gains, the tax laws provide an alternative: you can either use the loss in future periods against future capital gains or, if you have declared a net capital gain in one of three previous years (2000, 2001 or 2002), you can carry it back.
Carrying net capital losses from 2003 back to previous years can be a good move, because you will immediately recover income tax that you have already paid. Elections to carry back losses must be made using the appropriate forms (T1A for federal tax and TP-1012.A for Québec) and not by filing a modified return.
The federal T1A form can be joined to your income tax return or sent under separate cover, but the Québec TP-1012.A form must be sent under separate cover. If your income tax returns are filed electronically, you must send a printed version of these forms to the appropriate tax authorities.
Measures affecting retirement savings
The ceiling for contributions to retirement savings plans has been increased; it goes from $13,500 (for 2002 and previous years) to $14,500 (for 2003) and $15,500 (for 2004).
For 2004, the maximum annual contribution to an RRSP is 18% of income earned in 2003 up to a limit of $15,500. In other words, in order to contribute the maximum amount to your RRSP in 2004, you must declare at least $86,111 in income in 2003.
If, however, you participate in a registered pension plan or a deferred profit-sharing plan, you must take your 2003 pension adjustment into account when determining the allowable contribution to your RRSP in 2004.
Amount for persons with disabilities
If you are claiming the disability tax credit for the first time, you must have Form T-2201 filled out by a physician or another authorized person and file it with tax authorities. This form must be received and examined by tax authorities before your income tax return is assessed. If you have already filed this form for a previous taxation year, you do not have to file it again.
The fact that you receive a disability benefit under the Canada Pension Plan or the Québec Pension Plan does not necessarily make you eligible to claim the disability tax credit. The equivalent of the disability tax credit in Québec is the “amount respecting a severe or prolonged mental or physical impairment.” The required form is TP-752.0.14.
Security options
If in a previous year you elected to defer a benefit related to the exercise of stock options, and you still hold these shares as at December 31, 2003, do not forget to fill out and attach form T1212 to your federal income tax return. This form advises the tax authorities that you are still holding these shares and that the measures deferring the tax on this benefit are still in force. This form has no equivalent under Québec legislation.
The deduction for security options, found at line 297 (“Miscellaneous deductions”) of your Québec income tax form, is equal to 37.5% of the taxable benefit related to shares if the deduction is due to an event that took place after June 12, 2003. For events which occurred before June 13, 2002, the deduction is still 50%, as it is under federal law.
New mechanism for the transfer of non-refundable tax credits from one spouse to another (Québec)
As of 2003, you may transfer to your spouse that portion of non-refundable tax credits not used to reduce your own income tax, whether you file under the general or simplified tax system.
For the transfer of refundable credits to be carried out properly, you and your spouse must each have filed an income tax return. Technically, this measure has been implemented by eliminating lines 362 to 366 (“Amount respecting a spouse”) of the general tax return and by adding line 440 (“Credits transferred from one spouse to the other”).
Modifications to simplified system (Québec)
If you use the simplified tax system, you can now gain access to deductions and credits that were not previously available to you under this system. These deductions pertain to:
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Deductible support payments
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Residents of designated remote area
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Moving expenses
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Expenses incurred to earn investment income
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Allowable business investment losses
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100% basic deduction for flow-through shares
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Judicial expenses and expenses relating to an objection
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Exploration fees incurred in Québec
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Deduction respecting an amount exempt from income tax under a tax treaty or agreement
The credits include:
Finally, it is worth noting that you can no longer transfer dividend income under the new system for transferring credits between spouses.
Québec designated trust
If you resided in Québec on December 31, 2003, and you were a beneficiary of a designated trust, you must complete Form TP-663, Information Return to Be Completed by the Beneficiary of a Designated Trust, and check Box 22 of your Québec income tax return.
The expression “designated trust” means any trust resident in Canada but outside Québec. As a rule, the residence of a trust is the residence of the trustee. Under federal legislation, if the trustee elected, after July 11, 2002, to have the income and taxable capital gains taxed in the hands of the trust, and you are the “designated beneficiary,” then in addition to completing Form TP-663, you must include your share of this income when calculating your income for Québec tax purposes. You may be eligible for a tax credit for a beneficiary of a designated trust (line 411 of Schedule E).
A “designated beneficiary” of a trust means a beneficiary who has a share of $5,000 or more of the income interests or 10% or more of the capital interests (or of the income interests) of a designated trust. The purpose of this measure is to counter certain tax planning measures implemented in the past few years by Québec taxpayers wanting to benefit from more advantageous tax rates offered in other Canadian provinces, namely in Alberta.
By requiring designated beneficiaries to include their share of the trust income in their 2003 income tax returns and granting them a non-refundable income tax credit, the Québec government forces these taxpayers to pay the difference between the Québec taxation rate and that of the other province on the income elected by the trustee. Taxpayers who fail to include this information in the forms, or the amounts in their income tax returns, face severe penalties. You should consult your tax advisor if you are affected by this measure.
Entertainment expenses (Québec)
If you operate a business in Québec and incur expenses for meals, beverages or entertainment, you must limit the amount you claim for such expenses incurred after June 12, 2003 to 1% of your annual sales (gross income). You must also take into account the fact that only 50% of these expenses are deductible.
For 2003, annual sales and the 1% ceiling are calculated as a proportion of the number of days in your fiscal period falling after June 12. Entertainment expenses that are already excluded from the 50% limit, such as the cost of subscriptions to specific cultural events taking place in Québec, are not subject to the 1% ceiling.
If your activities regularly result in food and beverage expenses that are incurred at locations that are 40 kilometres or more from your place of business, you do not have to apply the 1% ceiling. If your business consists of operating a sales agency that sells goods from inventory, you will have to determine your ceiling by using a specific formula.
If you are a member of a partnership and you deduct entertainment expenses from your portion of the partnership’s income, you can no longer do so for expenses incurred after June 12, 2003.
Judicial or extrajudicial expenses related to support payments (Québec)
If in 2003 you had to pay judicial or extrajudicial fees to obtain the initial right to receive support payments, you can deduct these fees from your revenue as long as you have not been reimbursed, and do not have the right to be reimbursed, for these expenses.
The same principle applies if you incurred legal or extrajudicial costs with respect to the initial obligation to pay support. If you have incurred such expenses for a year prior to 2003, but such payment was not ordered as at December 12, 2003 (the day the new measure was announced), you can claim a correction for these years. The federal government has not changed its position with respect to these costs.
How to Reduce the Tax You Pay
Do you want to save taxes for 2003 and implement effective tax planning throughout 2004? If so, you should obtain a copy of the 16th edition of How to Reduce the Tax You Pay, written by members of our firm. With over 360,000 copies in print, this popular annual book, published by Key Porter Books Limited, is available in bookstores across Canada for $16.95 a copy.
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