TaxBreaks, August 2004
Lump-sum payments under automobile leases
Alternative solutions for expatriate assignments
Did you know that . . .
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Lump-sum payments under automobile leases
Leasing an automobile results in substantial expenses for the lessee, who not only must pay the leasing costs and operating expenses, but must also sometimes make certain lump-sum payments at the beginning or end of the lease. These payments are typically made to reduce the monthly payments, when the lessee terminates the lease before the expiry date, or when the distance driven exceeds the limit stipulated in the contract.
This article examines the tax consequences of lump-sum payments on the calculation of the taxable benefit to an employee, and on the expenses that a lessee may deduct.
Calculation of the taxable benefit
When an employer makes an automobile available to an employee, the employee, when calculating his or her income, must include an amount corresponding to the value of the taxable benefit received. The value of this benefit is comprised of two items that must be calculated separately: operating expenses and an amount for the right to use the automobile (standby charge).
Operating expenses, which include items such as gas, maintenance, repairs and insurance, are generally calculated on a prescribed, fixed-rate basis per kilometre travelled for personal purposes. This rate is currently $0.17 per kilometre.
As for the standby charge, in the case of a leased automobile, the taxable benefit is equal to two-thirds of the leasing expenses of the vehicle. The amount of this benefit can be reduced when the automobile is used more than 50% for employment purposes and when the personal use of the vehicle by the employee does not exceed 1,667 km per month (20,004 km per year). When the employee uses the automobile solely for employment purposes, the standby charge is automatically reduced to nil.
All leasing expenses must be considered when calculating the standby charge, including lump-sum payments made at the beginning or end of the lease.
Consequently, when a lump-sum payment is made at the beginning of the lease, for example, to reduce subsequent lease payments, leasing expenses for purposes of an employee’s taxable benefit are increased. In such cases, the Canada Revenue Agency (CRA) and Revenu Québec nonetheless allow this payment to be allocated equally over the entire duration of the lease, which does not unduly penalize the employee during the initial year of the contract.
However, a lump-sum payment made at the end of the lease for excess mileage, for example, also requires an adjustment to leasing expenses, because this payment indicates that the expenses were undervalued at the time the lease was signed. The CRA proposes two ways to account for this type of payment when calculating leasing expenses. The first consists in adding the total lump-sum payment to the leasing expenses of the year in which the contract expires, thus increasing the employee’s taxable benefit during that year alone. The second method involves allocating the lump-sum payment over the entire duration of the lease and, consequently, an adjustment to the employee’s income calculation for each year during which the automobile was at his or her disposal. For this purpose, the employer must obtain the employee’s approval to amend the T4 or T4A slips of the years in question and then add a portion of the lump-sum payment. The employee must then request a tax adjustment for those years from a tax services office or a tax centre. Revenu Québec also accepts these two methods of proceeding.
Although the second option at first seems very attractive – as it enables the employee to allocate the payment over the duration of the lease, thus reducing the effect of a lump-sum payment on the taxable benefit – its administrative complexity may discourage most people. It may, however, present sizable benefits in some cases, for example, when the automobile is not at the employee’s disposal during the entire period of the lease.
Deduction of expenses
A taxpayer may deduct, as part of his or her business income and, under certain conditions, as part of his or her employment income, all the reasonable expenses related to the use of an automobile (fuel, maintenance and repairs).
However, the law currently limits the deduction of leasing expenses to a maximum of $800 per month, plus taxes. When a lump-sum payment is made by the lessee at the beginning of the lease to reduce monthly payments, this amount must be allocated over the entire duration of the lease. If the sum of the lump-sum payment divided by the number of months stipulated in the lease, plus the monthly payment, exceeds the limit prescribed by law, the excess cannot be deducted.
Since the lump-sum amounts paid at the end of the lease (e.g., penalties for excess mileage) are part of the leasing expenses, they are included in the $800 monthly limit for deduction purposes.
The CRA considers that the deduction of a lump-sum payment made in lieu of terminating a lease before its expiry date depends on the terms of the lease. When a lump-sum payment is made to compensate the lessor up to an amount equal to the monthly payments for a shorter lease term, the CRA is of the opinion that such an amount is deductible. As in the case of a payment for excess mileage, the total deduction is limited to the maximum prescribed by law. For its part, Revenu Québec considers that the penalties for terminating a lease are part of the leasing expenses only when they are established based on the automobile’s resale value upon termination, or if they result from a rental charge adjustment.
Note that the taxable benefit that an employee must include in his or her income does not have an impact on the allowable deductions of the employer. These two calculations are completely independent of one another.
Patrick Bilodeau, Montréal
Marc Gravel, Montréal
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Alternative solutions for expatriate assignments
The number and frequency of traditional expatriate assignments has decreased for a variety of reasons, including political and market uncertainty within the world, a changing view that global experience is a necessity for executive development and corporate succession planning and a focus on the cost impact of such assignments. Alternatives to a traditional expatriate assignment include a fixed-term package with local compensation and benefits.
Challenges with fixed-term contracts
Companies within Canada wishing to implement these fixed-term local contracts can encounter many issues, the largest of which is the perceived tax rate differential between Canada and other countries. The challenge for Canadian companies recruiting talent to Canada is not only the overall effective tax rate, but the income level at which one reaches the maximum tax rate. Many companies attempt to resolve the tax rate differential by offering a supplement to an individual’s home compensation. This practice may very well result in a compensation package that is completely unaligned with the local pay scales. We have developed a variety of innovative tax strategies to assist companies in attracting and retaining employees in Canada for a fixed-term local contract.
Solutions
Deloitte has developed the following highly tax-effective solutions to minimize or eliminate the perceived tax rate differential for individuals being transferred to Canada for a period of time on a local contract.
Immigrant trust. Recent legislation has made this idea both more appealing and readily accessible for individuals moving to Canada with significant assets. The key benefits and implementation steps include:
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Effective mechanism to eliminate current taxation of non-Canadian investment income
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Elimination or reduction of departure tax exposure
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Individual immigrant trusts are established for executives transferred to Canada
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Each executive settles a non-resident trust and transfers their non-registered investment assets to the trust
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60-month tax holiday for non-Canadian investment income earned within trust
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Any growth in value of the assets during that 60-month period will not be taxed in Canada
Restricted stock. The legislation with respect to the taxation of restricted stock varies by country. These differing tax rules can create differences with respect to the timing of income recognition that may work to decrease tax rate differentials between countries. The key implementation steps for a U.S. employee transferring to Canada include:
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Restricted stock is granted to a U.S. employee prior to the Canadian transfer. Stock could be company’s own stock or any other publicly traded company.
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Portion of shares’ restrictions lapse each year during the Canadian contract
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Shares are sold as restrictions lapse, and proceeds used to pay Canadian and U.S. taxes. When shares are sold, a taxable benefit is included in the employees’ ordinary income for U.S. purposes. However, for Canadian purposes, only share appreciation since entering Canada is taxable.
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No benefit in respect of the stock grant is included in the expatriate’s Canadian taxable income, because the taxable event happened prior to the expatriate arriving in Canada
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Significantly reduces the cost of providing additional net compensation to an employee from the traditional gross-up method
Retirement Compensation Arrangements (RCAs). This tax planning strategy is extremely effective for the transfer of employees from the United States to Canada, but may also prove beneficial for employees transferring from European countries. The implementation of this idea is also available for use by Canadian executives intending to cease Canadian residency and retire in the United States. The benefits include:
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Reduction of overall tax rate of U.S. citizens working on temporary assignments in Canada
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Minimization or elimination of excess U.S. foreign tax credit carry forwards that usually accumulate due to higher Canadian tax rates
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These carryovers will be rendered useless if, after return to the United States, no foreign source income is earned
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Proper implementation can equalize Canadian and U.S. income tax rates
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Provide supplementary pension arrangements for transferring executives
Chris Marineau, Toronto
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Did you know that . . .
Revenu Québec intends to issue new notices of assessment in late Summer or early Fall for individual taxpayers who paid AMT for 2003.
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Prescribed interest rates for the third quarter of 2004. The prescribed interest rates that apply for federal income tax purposes for the third quarter of 2004 (July 1 to September 30) are: 6% on overdue taxes, Canada Pension Plan contributions and Employment Insurance premiums; 4% on overpayments, and 2% on taxable benefits for employees and shareholders from interest-free or low-interest loans. These rates are one percentage point lower than they were during the preceding quarter. For Québec income tax purposes, the corresponding rates are: 7% on amounts owed by taxpayers (unchanged from the preceding quarter); 1.25% on refunds (down from 2% in the preceding quarter), and 2% on taxable benefits for employees and shareholders from interest-free or low-interest loans (down from 3% in the preceding quarter).
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Tax Freedom Day for Canadian taxpayers. This year, Canadians celebrated Tax Freedom Day on June 28, one day later than last year, according to calculations by The Fraser Institute. What this signifies is that Canadians worked until June 27 to pay the total tax bill imposed on them by all levels of government. On June 28, Canadians started working for themselves. The concept of Tax Freedom Day provides an interesting reflection on the overall tax burden, despite the fact that taxes are actually paid throughout the year. While June 28 was the date for the country as a whole, the precise date varied from Province to Province. The earliest date was June 10 in Prince Edward Island, while British Columbia had the latest date, July 3.
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CRA changes its position on single-purpose corporations. The Canada Revenue Agency (CRA) has reviewed its administrative position not to assess a taxable benefit under the Income Tax Act where the taxpayer is the shareholder of a single-purpose corporation that has been established to hold U.S.-based real property. Effective immediately, the acquisition of property by a single-purpose corporation or the acquisition of shares of a single-purpose corporation (other than by way of death) will generate a taxable benefit for the shareholder. However, the administrative policy will continue to apply to those arrangements that are currently in place until the earlier of the disposition of the particular U.S.-based real estate by the single purpose corporation or the disposition of the shares of the single-purpose corporation other than a transfer to the shareholder's spouse or common-law partner as a result of the death of the shareholder.
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New health premium hits Ontario paycheques. Starting on July 1, 2004, the new Ontario Health Premium announced in the May 18 provincial budget began to be deducted from the paycheques of most Ontarians as part of the amount withheld for income tax. The premium is phased in as income rises, with the maximum payable being $450 in 2004 and $900 in 2005.
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