Claiming Gas or Mileage? How to avoid having this expense denied by the Canada Revenue Agency.

Many taxpayers here in Canada are advised to “keep their receipts” when they claim mileage and / or gas on their tax returns.  The thought here is that the Canada Revenue Agency (CRA) might audit your tax return and will deny your claim if you cannot show proof, but what are you allowed to deduct?  Does it matter if you are self-employed or if you are a salaried employee?  Did you know that just keeping your receipts is not enough and there might be deductions you are entitled to that you are not claiming?

It all matters.

If you are claiming vehicle expenses and you are a salaried T4 employee working for someone else, then you need to know this;

Or, if you are self employed, you need to know this;

So if you rely on your accountant to take care of this for you, or if you wish to use the services of Intaxicating Tax Services, at the very least, you need to be aware of this important fact;

The CRA regularly rejects gas receipts from taxpayers who pay for their gas with debit cards.  Why?  Because they are not sure if you are getting cash back on the transaction – that does not show on the debit slip.

Example: I go to fill up my car 3 times a week, and each time I put in $20.00 worth of gasoline, but get cash back of $80.00 each time.  My debit slip reads $100.00, and I claim $300.00 worth of gasoline expenses for that week on my tax return when in actual fact I was only entitled to receive a deduction in the amount of $60.00.

In addition, if you are required to travel a lot for work, make sure that you have a calendar at home and at the office (on the office computers) which show the location of the meeting, the name of the organization and / or people that you are meeting, as well as the purpose of the meeting (ie/ sales, cold call, delivery).  Make sure that you track the mileage as well.  This way when the CRA questions the high claims, you can show them with 100% certainty that your travel claims are for work purposes.

It also helps to keep all the gas transactions on the same credit card for organizational purposes.

It takes a little effort and organization but it’s worth it.

Intaxicating Tax Services can be found @ http://www.intaxicating.ca and make sure to drop by our helpful blog here.

CRA Tightening the ship and tightening their grip…

Income tax
Income tax (Photo credit: Alan Cleaver)

I’m sure you have heard that the Canada Revenue Agency (CRA)is tightening the ship and cracking down on tax evasion, tax shelters and finding new ways to collect more tax dollars.  Well you can thank the IRS for that.  With the IRS predicting that there are billions and billions of dollars of offshore tax revenue that they expect to bring in through FATCA it’s no wonder revenue agencies throughout the world are looking at better ways to collect tax revenues from their citizens here and abroad.

Riding the wave of FATCA, the CRA has been making public information on ways they can collect tax revenues and highlight some techniques they have been using as far back as when I worked in the CRA but may not have been so widely known to the general public.  The point is that if you know all the powers the CRA has, and know they are cracking down, then you can conclude pretty quickly that you will get caught doing whatever you may be doing that is illegal; not remitting or reporting GST/HST, accepting cash for work and not reporting it, paying an employee under the table, not declaring all your income or just not filing and hoping to stay under the radar.

The CRA’s Snitch line / Informant Leads line has been a fantastic resource for the CRA and has brought in more leads than they ever could have anticipated when creating this line.

So what is the CRA doing that you might not know about?

Data Mining

The CRA can, and have been data mining publicly available property tax information to confirm that sales or transfers of real property have been properly reported by taxpayers and they are using this information to identify taxpayers who are incorrectly reporting property sales at the preferential capital gains tax rate, or who have been flipping properties for quick gain and should be reporting them as sale of inventory, or they have been aggressively claiming properties as their principal residences and avoiding paying taxes altogether.

Tax slip matching

Advances in technology now allow the CRA to quickly determine whether a taxpayer has reported all income listed on all tax slips. Every entity, whether it as a corporation, trust, financial institution or employer is required to issue a tax information slip to all its income recipients. Typically, the area where the CRA reassesses a tax return is on unreported employment income and interest and dividends. The CRA also focuses on sales of marketable securities reported to them on the T5008 information slip. If you’ve mis-reported income multiple times, you are subject to penalties which in some cases are as high as 20% of the omitted amount. For low income earners, this can add up to more than the tax itself.

The Construction Industry

The CRA has always been concerned about construction workers not reporting all of their income which is why they piloted and maintain “Construction Teams” in the Tax Services Offices.  The new information reporting requirement on form T5018, provides the CRA the ability to ensure the proper amount of tax is being paid by construction workers and frequent audits ensure payments to workers and amounts they reported fall in line as well.

Tax shelters / Off-shore Accounts

What was once considered a safe haven where wealthy investors could put monies out of reach of their governments has now become a bone of contention as investors want to pay as little tax as possible, governments want as much tax as possible – especially from these high net-worth people and the general public want the wealthy to pay more taxes!  FATCA got the ball rolling and now the CRA has followed suit, seeking information of the investors before then taxing them back on their offshore accounts.

Tax shelters, while shielding investors from paying tax on current income, likely will have to pay taxes at some point in time down the road as the CRA tightens the regulations on these investment tools to ensure they are not tax evading schemes.

Illegal activity / Informant Leads (Snitch) Line

The CRA has its ears on the ground more than ever and the Canadian Border Services Agency (who used to be part of the Canada Customs and Revenue Agency) are locating and turning up illegal activity and the CRA is following up that criminal activity with assessments and re-assessments.  Combine that with the Informant Leads line and you can quickly conclude that to the CRA crime does not pay, but criminals should pay taxes too.

Charitable donations

The CRA’s reach extends to the charitable sector as well.  Both donors and registered charities are heavily scrutinized for potential fraud especially around those donating non-cash gifts.  The CRA is looking to ensure that the amount reported on the donation receipt (and the corresponding credit claimed by the donor) accurately corresponds to the value of the donated item, and that the value is as close to fair market value as possible.

The CRA has been using these techniques for years to ensure taxpayers are paying their fair share on all sources of income and are doing so without increasing the number of employees dramatically which means a few things;  First, it may be worthwhile to review your previous filings and – if errors are identified as a result of that review – take advantage of the voluntary disclosure program.  Second, in the voluntary tax system we have in Canada, the onus is on you, the taxpayer to prove to the CRA that you are operating in line with CRA regulations which means keeping great records, having professional help and keeping receipts.  Thirdly, if you are off-side with CRA regulations and want to know what may happen to you if you get caught, you should give us a call.

Tax Season in Canada… When can you expect to see your slips, receipts and returns?

Tax time in Canada.

April 30th for most Canadians and June 15th for self-employed Canadians.

So much fun… Really.  Organizations who issue tax slips, tax returns or contribution receipts have been working hard perfecting their processes since the end of the last tax reporting season and have been working through the summer putting any necessary changes in place and gearing up for the next tax season – which all begins next month in November for many top organizations.

Since issuing organizations are gearing up, so should you, the investor, start getting ready to file your income tax returns and to do that, it really helps if you have an idea as to which slips your investment(s) will generate and when you can expect them.

Of course, even if you do get all your slips, as expected, there could always be amended slips sent to you as well resulting from an error or late directional change from the company / fund.  Even the CRA sometimes are required to make changes to their tax forms, or to the calculations contained therein and there is nothing you, nor your tax preparer can do, let alone the poor folks issuing your tax slips.  You have a slip, assume it to be correct and file to the CRA with it only to find out it’s incorrect when another version comes, with a letter, to be used instead.

Take 2010, for example… The CRA changed the dividend tax rate by something like 0.0007% and they did that 5 days before they expected T5 slips to have been received by holders and in actual fact, most of the T5’s were already issued with the incorrect rate before the CRA realized what they had done.

Since the CRA determined that the rate change would be adjusted internally, there was a communication fired out industry-wide notifying those who received T5’s that no further actions would be taken on the holder side and that they should not need to go back to their bank, financial institution or transfer agent to have it amended.  I remember a few individuals demanding their slips being amended for a total change of $7.00.  But this is what you do – with a smile when you’re in that industry.

Back to the topic.

One of the most common frustrations during tax preparation time comes from those holders who are eager to file but are unsure of what they are getting and when, roughly, it should arrive.

Due Dates

Keeping tabs on due dates can be quite difficult, especially if you’re getting them from an organization which has not fully embraced social media and are unable to provide you with a timeline, or expected dates per slip depending on what you should be receiving.

For example, T4 and T5 tax slips must be mailed out by February 28th whereas, tax slips for mutual funds, flow-through shares, limited partnerships and income trusts are not due until March 31st.

When there are late deadlines, like March 31st, a lot of pressure is then placed on your accountant as it creates a heavy backlog in April, when accountants must rush through the preparation of personal tax returns for their clients – sadly unable to give each return the care and oversight that they deserve.

I just don’t understand why all slips are not made available on the web or by email all by say March 10th in order to allow time for issuing organizations to prepare better their processes to allow for additional oversight and for time to correct errors.  This way organizations preparing the slips will have to begin auditing the slips traditionally due in February for errors and get the March ones completed – have them all merged together in the same file and made available sooner rather than later for the holder.  In addition, with a fixed deadline, the CRA or MRQ would then know when they can or cannot change slips or information on slips.

Let’s look a little closer at some issues and potential solutions;

Year-end trading summaries

Banks and brokerages use year-end trade summaries to report proceeds and commissions on each sale. However, the proceeds reported are sometimes net of commissions, which can lead investors to erroneously deduct the reported commission number a second time.  In addition, many banks issue multiple slips for each investment account, but send a consolidated summary of the slips to the CRA, which causes havoc when there is a missing slip or a question regarding one of them.

By keeping track of the totals or having them all come in March would allow the issuing organization time to audit and compare the slips to the summary before issuing to ensure they balance.

Another solution is for the issuing organization to make the slips available on their investor website and then holders can wait for the year-end summary to post – which of course would balance – and then before a holder does anything with their slips they can be comfortable that they balance.

An additional bonus would be for the issuing organization to also provide the calculations behind the slips on the website so that if there is a discrepancy, the holder can look to see how the slips were calculated and they can also learn more about how taxes are calculated.  It’s a win-win situation.  Accurate reporting and teaching the holder more about taxes.

Gain and loss reports

Many privately managed bank funds prepare gain and loss reports for clients. However, where there are US stock sales, often the cost reflects the US dollar purchase amount at the current year’s exchange rate, rather than at the time of purchase.

Traditionally, the onus is on the holder to figure out the historic exchange rate and the issuing organizations can and should assist by making this information available on their website for ease of balancing.  They should also make sure that there is accurate and complete documentation on their website and on all reports indicating the rate used and the rate needed for reporting.

T3 and T5013 tax slips

These are the two main slips which have a mailing deadline of March 31st because the trust/partnership has to finalize their books and prepare their tax returns in order to know the breakdown of the distributions so that the individual holders can then have their tax returns rushed to them – a high risk process indeed.  So once the T5’s have been received and accounted for, issuing organizations like transfer agents have only a month or less to then prepare the T3 and T5013 slips.

Let’s be honest here, it’s more like 2-3 days, due to the complexity of the partnership returns and one way around this is to ensure that any issuing organization is capable to preparing T5013’s by themselves, or that they have an organization capable of preparing them in an expedited manner.  In addition, the partnership should be contacted to let them know that the quicker they get their books in order, the quicker the rest of the slips can be prepared.  If enough people come forward, I guarantee it will get done faster.

Final Review:

When reviewing your slips before filing your tax return, keep in mind a few small differences;

T4’s vs. T4A’s – A T4 is issued by your employer and reflects the income you earned during the year, as well as showing the amount of deductions you had removed from your pay, such as; CPP, Employment Insurance (EI) and tax.  A T4A, on the other hand, is issued by a pension plan administrator and reflects the pension income you received from a pension source. T4As will not have figures listed for CPP or EI contributions since these are not deducted from pension income.

The T5 investment income slip – identifies the various types of investment income that residents of Canada have to report on their income tax and benefit returns.  T5’s are NOT issued to report income paid to non-residents of Canada, however, if you earned US interest on your investments, it will show up on your T5, with a note at the bottom saying that the interest is in US dollars.

It’s not always clear to the holder that this figure needs to be converted at the average exchange rate for the year, as set out by the CRA.   T5 slips also have both eligible and ineligible dividend boxes, which holders can accidentally reverse on their returns.

Investment loan interest

Most banks do not issue receipts for interest on investment loans unless specifically requested, resulting in a missed deduction for the client.  Borrowers should request receipts well in advance of the tax-filing deadline to ensure they arrive in time.

All in all, it’s best to keep track of investments you have and to check off when they are expected and when they are received in order to ensure you can file at your earliest convenience or reach out and ask your issuing organization / bank / transfer agency to step up and find a solution.

It’s never to early.

Even in October.

FATCA Fallout: This was NOT what the IRS intended with the upcoming FATCA Regulations

This image depicts the total tax revenue (not ...
This image depicts the total tax revenue (not adjusted for inflation) for the U.S. federal government from 1980 to 2009 compared to the amount of revenue coming from individual income taxes. The data comes from the Office of Management and Budget’s record of the ‘Budget of the US Government FY 2011’, specifically the ‘Historical Tables, Table 2.1.’ The information is also here. (Photo credit: Wikipedia)

I have been all over FATCA since March 18th, 2010 when President Obama passed the Hires Act through Congress, aimed at getting Americans working and taxing the wealthy (isn’t that what all socialist and democratic governments do?)  Out of this Act comes FATCA, the Foreign Account Tax Compliance Act which is set to become law January 1st, 2013 and unlike most new taxes, FATCA changes the way taxation is administered globally.I’m going to outline why FATCA was brought in, what the US government is trying to do, and why there have been a couple of events in the past 2 weeks which have come to light which leads me to believe that this was not what the US government was thinking when they pushed the Hires Act through Congress.

So FATCA, in case you are unaware, is on its way to becoming the world’s first global tax on Americans, administered by financials institutions and non-financial entities around the world… OR else.  Can the IRS do this, you ask?  Apparently yes they can.  Why do they need to do this you are wondering?  Because US investors have been evading taxes by hiding their identities from the IRS or they have created offshore companies to hold their investments out of sight and out of reach of the IRS.  The net result here is that the IRS needed to find a way to track down all these US persons who should be filing US tax returns disclosing all their worldwide income but are either not filing, nor including these items.

The estimated lost tax revenues from these US taxpayers using offshore schemes to evade US income taxes is in excess of $100 billion dollars per year.  Think the US could use these funds?  Yeah, I thought so too.  Say hello to FATCA.
So how can the US crack down on these US persons who are hiding their funds?  Well first they tried asking some foreign banks for a list of Americans who they had on their registry.  That did not go over well at all.  The banks said, you have a specific person you want information on, we will give you details, however the IRS didn’t know, they wanted everyone and the foreign banks we not going to give us their revenue sources.  So the US government sued beginning with  Switzerland.  Not the best way to win friends, globally, by suing them, so the US government and the IRS them began pushing FATCA on everyone.
In a nutshell, it requires all foreign banks and foreign institutions to provide information to the IRS as soon as they find a US person on their system / in their bank.  The IRS intends on using this information to locate, audit and potentially prosecute US persons who are evading the paying of their fair share of taxes.  The scope of FATCA is global.  The complexity of FATCA is massive.
The IRS figures through FATCA that every organization globally will opt in to FATCA and will become agents of the IRS and within 5 years will have flushed out every US person to the IRS – both those who are complying and those and those who are not (those who are not have a catchy new name: recalcitrant).
The IRS even offers a way out of FATCA if you are an US person… Just give the IRS 1/3rd of your worldwide income and renounce your US citizenship and you’re out.  For good.
Recently, however, I came across two fantastic articles through my FATCA research which clearly shows me that the IRS and the US government may not have thought through the full implications of FATCA.
So here is problem number 1, in a great article from Bloomberg;

http://www.bloomberg.com/news/2012-05-08/u-s-millionaires-told-go-away-as-tax-evasion-rule-looms.html.  This article outlines the international response to FATCA as the deadline to sign up with the IRS gets closer and closer.  Instead of gearing up systems to flush out these US investors who have been hiding millions and millions of dollars (the FATCATs), these foreign financial institutions (FFI’s) and non-financial foreign entities (NFFE’s) are going through their foreign policies to find ways to instead remove Americans from their business.  The costs associated with complying with FATCA outweighs the benefit of US monies.  Oh oh.

Does the IRS and US government really want to prohibit US persons from investing outside of the US?

Problem number 2 came recently when Brazilian-born Eduardo Saverin, the billionaire Facebook co-founder, renounced his US citizenship he gained as a teenager in advance of the company’s impending IPO and moved to Singapore to avoid paying capital gains taxes on his approximately $3 billion stake in Facebook.

This is FATCA response #2.  Renounce your citizenship and you’re out.  So instead of staying in the US and paying taxes, the very rich do not appreciate carrying the taxation burden for a tax and spend government and they take their wealth to another country where it will be appreciated.

Caught red-faced the US government needed to respond so they looked to do to Saverin what they did to the foreign banks who had US persons on their registry.  They threatened to sue.  Then they changed the law.  The US senate introduced a bill under which any expatriate with either a net worth of $2 million, or an average income tax liability of at least $148,000, will be automatically presumed to be leaving the country for tax purposes — enabling the IRS to impose a tax on any investment gains that person makes in the future.  Crazy.  Greedy.

Apparently Saverin filed to give up his US citizenship in January of 2011, but the news didn’t surface until the federal government released the information in a routine report. Saverin may be barred from re-entering the US if authorities decide he left the country for tax reasons because you don’t want a super-rich guy coming into your country and buying things!  That will show him.

Singapore doesn’t have a capital gains tax. It does tax income earned in that nation, as well as “certain foreign- sourced income.”  Saverin won’t escape all US taxes because Americans who give up their citizenship owe what is effectively an exit tax on the capital gains from stock holdings.

Saverin maintains that his renunciation of American citizenship, which actually took place last September, wasn’t a ploy to skip out on American taxes, but rather an attempt to free himself from FATCA, which he described as a burdensome restrictions on American investors abroad. US citizens are severely restricted as to what they can invest in and where they can maintain accounts.  Many foreign funds and banks won’t accept Americans so it was for financial reasons and not tax related.

It’s true that FATCA is making life more difficult for US persons, including the IRS’ global reach (many countries tax based on residency); foreign bank account reporting rules; and FATCA.  As a result of all the regulations, some foreign banks are dumping more U.S. customers.

Saverin is hardly the only one taking this particular route to big tax savings. The number of those renouncing US citizenship stands at around 1,800 last year.

While I cannot see the US government pulling back on FATCA I think they need to look again at what they are trying to accomplish and how they plan on getting there before all their high-income earners not in the US disappear from the radar within 5-10 years of FATCA being in force.  So the tax pool will grow, then diminish and the IRS will be looking for newer ways to increase tax revenues.

Some basics of Canadian Investing; Mutual Funds, Eligible Dividends and Deferred Tax

Here is a brief introduction to the absolute basics of investing Canada. If you know this, you really just know the basics.  If you do not know much about Mutual funds, Eligible dividends, income trusts, and deferring taxes owing then trust me, this is the tip of the iceberg.  The Investment Fund Institute of Canada (IFIC) has a mutual fund course as probably does the Canadian Securities Institute (CSI).  Both are sought after for entry into the financial sector.

At the very basic, here are the 2 main types of tax-sheltered investments you probably have heard about – RRSP or RRIF.  In both cases, you put money away into these investments which are NOT taxed at year-end.  you pay taxes when you withdraw or remove the funds after certain milestones, such as age 65. 

Investments that generate capital gains or Canadian source dividends are taxed more favourable than interest income because interest income earned from investments such as T-Bills, bonds, and GIC’s are generally taxed at the highest marginal tax rate.
• Dividends earned from a Canadian Corporation are taxed at a lower rate than interest income.  This is because dividends are eligible for a dividend tax credit, which recognizes that the corporation has already paid tax on the income that is being distributed to shareholders.
o This only applies to dividends from a Canadian corporation.
o Dividends paid from a foreign corporation are not eligible for the dividend tax credit.

As of 2006 there are now two types of dividends, eligible and non-eligible dividends, and they are treated differently from a tax perspective.
• Eligible dividends include those received from a public Canadian corporation and certain private, resident corporations that must pay Canadian tax at the general corporation rate. As a result, they have a federal tax credit of 18.97% and are grossed up by 145%.
• Non-eligible dividends include those received from Canadian-controlled private corporations not subject to the general corporate tax rate.  They have federal tax credit of 13.33% and are grossed up by 125%.

This change was introduced by the government of Canada in order to present a more balanced tax treatment between corporations and income trusts as Canadians were investing more and more in income trusts and less and less in corporations and why wouldn’t they, since prior to 2006 income trusts were not taxed on any income allocated to unit holders, whereas dividends paid by a Canadian corporation are paid out of after tax earnings. 

To combat this, many corporations began to restructure their operations to become income trusts.  Something had to be done.

In a typical income trust structure, the income paid to an income trust by the operating entity may take the form of interest, royalty or lease payments, which are normally deductible in computing the operating entity’s income for tax purposes.  These deductions reduce the operating entity’s tax to nil.   

The trust “flows” all of its income received from the operating entity out to unitholders.  The distributions paid or payable to unitholders reduces a trust’s taxable income, so the net result is that a trust would also pay little to no income tax, which is never a good thing in the government’s eyes.

So who then gets hit with the tax bill??  The net effect is that the interest, royalty or lease payments are taxed at the unitholder level;
1. A flow-through entity whose income is redirected to unitholders, the trust structure avoids any possible double taxation that comes from combining corporate (T2) income taxation with shareholders’ dividend taxation
2. Where there is no double taxation, there can be the advantage of deferring the payment of tax.  When the distributions are received by a non-taxed entity, like a pension fund, all the tax due on corporate earnings is deferred until the eventual receipt of pension income by participants of the pension fund.
3. Where the distributions are received by foreigners, the tax applied to the distributions may be at a lower rate determined by tax treaties, that had not considered the forfeiture of tax at the corporate level.
4. The effective tax an income trust owner could pay on earnings could actually be increased because trusts typically distribute all of their cashflow as distributions, rather than employing leverage and other tax management techniques to reduce effective corporate tax rates.  It’s easier to distribute all the funds out and show nothing being retained that it is to implement strategies to reduce corporate tax owing which is the path most often taken. 

Where can a holder find their dividends reports?  Dividends are usually shown on the following CRA slips:
• T5, Statement of Investment Income
• T4PS, Statement of Employees Profit Sharing Plan Allocations and Payments
• T3, Statement of Trust Income Allocations and Designations
• T5013, Statement of Partnership Income
• T5013A, Statement of Partnership Income for Tax Shelters and Renounced Resource Expenses

When completing a Canadian tax return, where should a holder enter their dividend information?

Enter on Line 180 the taxable amount of dividends (other than eligible dividends) as follows:
• box 11 on T5 slips
• box 25 on T4PS slips
• box 32 on T3 slips
• box 51-1 on your T5013 or T5013A slips.

Enter on Line 120 the taxable amount of all dividends from taxable Canadian corporations, as follows:
• boxes 11 and 25 on T5 slips
• boxes 25 and 31 on T4PS slips
• boxes 32 and 50 on T3 slips
• boxes 51-1 and 52-1 on your T5013 or T5013A slips.

What do I do if I did not receive an information slips?

Ignore it and the CRA will let me off the hook?  No chance.  If you did not receive an information slip, you must calculate the taxable amount of other than eligible dividends by multiplying the actual amount of dividends (other than eligible) you received by 125% and reporting the result on line 180.  You must also calculate the taxable amount of eligible dividends by multiplying the actual amount of eligible dividends you received by 141%. Report the combined total of eligible and other than eligible dividends on line 120.

So what exactly is a capital gain?

Capital gains occur when you sell an asset for more than you paid for it. This gain is offset by any losses and can be further reduced by any expenses that are incurred by the purchase or sale of the asset – resulting in net capital gain.
Taxation of capital gains: 50% of a net gain is taxable at the appropriate federal and provincial rates.

My accountant advised me I need more “Tax deferral”.  What does she mean?   She means contributing the maximum amount to your RRSP which provides an immediate tax deduction and tax sheltered growth as long as the investment(s) remain in the plan.

Other less commonly used strategies include:
• Universal Life Insurance is a policy that combines life insurance coverage with a tax deferred investment component. Premiums paid are first used to ensure life coverage and the balance accumulates in an investment account where it grows tax deferred.
• Registered Educations Savings Plan (RESP) is a plan where contributions are used to fund a child or grandchild’s post secondary education costs.
o initial contributions are not tax-deductible
o any income earned within the plan is only taxable in the hands of the student at the time of withdrawal.

More is coming in the next few days, weeks and months…

Canadian Taxation Back to Basics: What is a T3 return?

Often times with all the complexities that come with International taxation we sometimes lose sight of the basic questions that come our way in the taxation industry.

For example, what is a T3?T3

A T3 slip is a Canadian tax form that reports income from trusts for a tax year.

An individual taxpayer will include the amounts reported on the T3 on his personal tax return.

A corporation will include it as part of its investment income.

A trust (or trustee / intermediary / transfer agent, etc.) is required to provide the T3 slip to investors by the last day of February in the following year.

So what again is a T3 slip?

A T3 slip details the various types of income distributed from the trust for a taxation year.

Why would an individual get a T3 slip?

The most common reason is for distributions or dividend reinvestments in mutual funds or segregated funds.  However, if these funds are held in tax-deferred retirement (RRSP) or education accounts (RESP), no T3 will be generated.  The reason no slips is issued in those cases is because the income in those types of funds is reportable for tax purposes once they are withdrawn from the fund.

The trust is responsible for filing copies of all T3 slips along with a T3 Return to Canada Revenue Agency (CRA) by the end of February in the following year.

What kinds of income can trusts distribute?

Trusts can distribute interest, royalties, business income, pension income and most commonly dividends and capital gains.

Each is recorded on a separate line on the T3 slip.  Each type of income is treated differently for tax purposes and appears in a separate location on the taxpayer’s personal income tax return.  Capital gains may be offset by other capital losses in the year or from prior years.

Filing a T3

A T3 is filed as part of a taxpayer’s T1 personal tax return.

When is a T3 required?

Regardless of the fiscal year-end of the trust, the T3 is generated and reported in the year the income is received.

Thursday Thirteen – IRS Style. 13 Facts about W9’s.

This Thursday Thirteen covers 13 facts about the IRS W9 Form you may, or may not have known about:

13. Which payees are exempt from backup withholding?
* An organization exempt from tax under section 501(a), any IRA, or a custodial account under section 403(b)(7) if the account satisfies the requirements of section 401(f)(2),
* The United States or any of its agencies or instrumentalities,
* A state, the District of Columbia, a possession of the US or any of their political subdivisions or instrumentalities,
* A foreign government or any of its political subdivisions, agencies, or instrumentalities, or
* An international organization or any of its agencies or instrumentalities.

12. Which payees may be exempt from backup withholding?
* A futures commission merchant registered with the Commodity Futures Trading Commission,
* A foreign central bank of issue,
* A dealer in securities or commodities required to register in the US, the District of Columbia, or a possession of the US,
* A real estate investment trust,
* An entity registered at all times during the tax year under the Investment Company Act of 1940,
* A common trust fund operated by a bank under section 584(a),
* A financial institution,
* A middleman known in the investment community as a nominee or custodian, or
* A trust exempt from tax under section 664 or described in section 4947.

11. The IRS recommends that even if you are exempt from backup withholding, you should still complete a W9 to avoid possible erroneous backup withholding.

10. What is the purpose of the W9?
A person who is required to file an information return with the IRS must obtain your correct taxpayer identification number (TIN) to report, for example, income paid to you, real estate transactions, mortgage interest you paid, acquisition or abandonment of secured property, cancellation of debt, or contributions you made to an IRA

9. Who needs to complete a W9?
A US person (including a resident alien), to provide your correct TIN to the person requesting it (the requester).

8. Why do “they” need a W9 completed?
* To certify that the TIN you are giving is correct (or you are waiting for a number to be issued),
* To certify that you are not subject to backup withholding, or
* To claim exemption from backup withholding if you are a US exempt payee.
(You are also certifying that as a US person, your allocable share of any partnership income from a US trade or business is not subject to the withholding tax on foreign partners’ share of effectively connected income)

7. If a requester gives you a form other than Form W-9 to request your TIN, you must use the requester’s form if it is substantially similar to this Form W-9. The IRS cares about the information on the form, not the form itself.

6. Penalties? Yup!!!
* Civil penalty for false information with respect to withholding. If you make a false statement with no reasonable basis that results in no backup withholding, you are subject to a $500 penalty.
* Criminal penalty for falsifying information. Willfully falsifying certifications or affirmations may subject you to criminal penalties including fines and/or imprisonment.
* Failure to furnish TIN. If you fail to furnish your correct TIN to a requester, you are subject to a penalty of $50 for each such failure unless your failure is due to reasonable cause and not to willful neglect.
* Misuse of TINs. If the requester discloses or uses TINs in violation of federal law, the requester may be subject to civil and criminal penalties.

5. What is backup withholding? Persons making certain payments to you must under certain conditions withhold and pay to the IRS 28% of such payments. This is called “backup withholding.” Payments that may be subject to backup withholding include interest, tax-exempt interest, dividends, broker and barter exchange transactions, rents, royalties, nonemployee pay, and certain payments from fishing boat operators. Real estate transactions are not subject to backup withholding.
You will not be subject to backup withholding on payments you receive if you give the requester your correct TIN, make the proper certifications, and report all your taxable interest and dividends on your tax return.

4. You will not be subject to backup withholding on payments you receive if you give the requester your correct TIN, make the proper certifications, and report all your taxable interest and dividends on your tax return.

3. If you are a US resident alien who is relying on an exception contained in the saving clause of a tax treaty to claim an exemption from US tax on certain types of income, you must attach a statement to Form W-9 that specifies the following five items:
1. The treaty country. Generally, this must be the same treaty under which you claimed exemption from tax as a nonresident alien.
2. The treaty article addressing the income.
3. The article number (or location) in the tax treaty that contains the saving clause and its exceptions.
4. The type and amount of income that qualifies for the exemption from tax.
5. Sufficient facts to justify the exemption from tax under the terms of the treaty article

2. To sign or not to sign…
To establish to the withholding agent that you are a US person, or resident alien, sign Form W-9. You may be requested to sign by the withholding agent even if items below indicate otherwise.
* Interest, dividend, and barter exchange accounts opened before 1984 and broker accounts considered active during 1983. You must give your correct TIN, but you do not have to sign the certification.
* Interest, dividend, broker, and barter exchange accounts opened after 1983 and broker accounts considered inactive during 1983. You must sign the certification or backup withholding will apply. If you are subject to backup withholding and you are merely providing your correct TIN to the requester, you must cross out item 2 in the certification before signing the form.
* Real estate transactions. You must sign the certification.
* Other payments. You must give your correct TIN, but you do not have to sign the certification unless you have been notified that you have previously given an incorrect TIN. “Other payments” include payments made in the course of the requester’s trade or business for rents, royalties, goods (other than bills for merchandise), medical and health care services (including payments to corporations), payments to a nonemployee for services, payments to certain fishing boat crew members and fishermen, and gross proceeds paid to attorneys (including payments to corporations).
* Mortgage interest paid by you, acquisition or abandonment of secured property, cancellation of debt, qualified tuition program payments (under section 529), IRA, Coverdell ESA, Archer MSA or HSA contributions or distributions, and pension distributions. You must give your correct TIN, but you do not have to sign the certification.

Bottom line… Sign it.

1. You will be subject to backup withholding on payments you receive if;
* The IRS tells the requester that you furnished an incorrect TIN,
* You do not certify your TIN when required,
* You do not furnish your TIN to the requester,
The IRS tells you that you are subject to backup withholding because you did not report all your interest and dividends on your tax return (for reportable interest and dividends only),
* You do not certify to the requester that you are not subject to backup withholding (for reportable interest and dividend accounts opened after 1983 only).

Good news for Canadians (and other non-US companies) regarding the IRS

The following IRS news release came across my desk late last week and it is good news for Canadians and other non-US organizations who have to interact with the IRS.

The IRS is finally recognizing that with their new expectations on foreign organizations (they call it international compliance), that they must provide resources to assist these organizations carry out the IRS’ requirements. To achieve this, the IRS will be adding 875 new staff! So we know they are serious…

These changes come into effect on October 1st, 2010.

Read on:

Release number:IR-2010-88
DAte of release: August 4, 2010

WASHINGTON — As part of a continuing effort to improve global tax administration efforts, Internal Revenue Service officials announced today the realignment of the Large and Mid-Size Business (LMSB) division to create a more centralized organization dedicated to improving international tax compliance.

As part of the organizational shift, the name of the IRS’s large corporate unit — LMSB — will change on Oct. 1 to the Large Business and International division (LB&I).

“Executing our international strategy is a top priority, and our work continues to intensify in this area,” said IRS Commissioner Doug Shulman. “Every day, we are moving forward in our international compliance efforts. Bringing together our top international personnel in this new group will help us advance our global tax administration efforts and ensure focus and fairness in a critical area for our nation.”

The new LB&I organization will enhance the current International program, adding about 875 employees to the existing staff of nearly 600. Most of the additional examiners, economists and technical staff are current employees who specialize on international issues within other parts of LMSB.

The realignment will strengthen international tax compliance for individuals and corporations in several ways, including:

Identifying emerging international compliance issues more quickly.
Removing geographic barriers, allowing for the dedication of IRS experts to the most pressing international issues.
Increasing international specialization among IRS staff by creating economies of scale and improving IRS international coordination.
Ensuring the right compliance resources are allocated to the right cases.
Consolidating oversight of international information reporting and implementing new programs, such as the Foreign Account Tax Compliance Act (FATCA).
Coordinating the Competent Authority more closely with field staff that originate cases, especially those dealing with transfer pricing.
Otherwise centralizing and enhancing the IRS’s focus on transfer pricing.
Heather C. Maloy will continue serving as Commissioner of LB&I. Michael Danilack, Deputy Commissioner, International, will head the realigned global unit. Paul D. DeNard will continue serving as Deputy Commissioner (Operations).

The new international unit will include a transfer pricing director, who will continue piloting the new transfer pricing practice, and a chief economist, who will oversee the IRS’s economic positions pertaining to transfer pricing.

“The realigned organization will let us focus on high-risk international compliance issues and handle these cases with greater consistency and efficiency as we continue to increase our work in this area,” Shulman said.

In addition, the realigned LB&I will continue to serve the same population of taxpayers — corporations, subchapter S corporations and partnerships with assets greater than $10 million as well as certain high wealth individuals.

Today’s announcement marks the latest in a number of efforts the IRS has made to increase international tax compliance. The IRS has taken major steps to address offshore tax evasion, including the investigation of the misuse of undisclosed offshore accounts by U.S. taxpayers. Last fall, the IRS created a Global High Wealth Industry unit to better monitor tax compliance by high income individuals and their related enterprises.

LB&I is also charged with overseeing the implementation of the recently enacted Foreign Account Tax Compliance Act (FATCA). Signed into law in March, FATCA will substantially improve international information reporting, increasing international transparency and compliance.

The IRS and the Department of Treasury have also worked to revise tax treaties and tax information exchange agreements (TIEAs) to increase transparency and to make it more difficult for taxpayers to evade taxes just by crossing international borders.

The link to the original article is here;
http://www.irs.gov/newsroom/article/0,,id=226284,00.html

Does the IRS owe YOU money?

This news release from the IRS made me laugh.

Entitled, “Does the IRS owe YOU money”, it made me think back to when the IRS did owe us money and that it took us almost a year to get it back from them.

Nonetheless, I wanted to re-post it and share any additional information I learned while dealing with the IRS.

Here is the IRS press release…

Unclaimed Refunds

Some people may have had taxes withheld from their wages but were not required to file a tax return because they had too little income. Others may not have had any tax withheld but would be eligible for the refundable Earned Income Tax Credit.
•To collect this money a return must be filed with the IRS no later than three years from the due date of the return.
•If no return is filed to claim the refund within three years, the money becomes the property of the U.S. Treasury.
•There is NO penalty assessed by the IRS for filing a late return claiming a credit (refund).
•Current and prior year tax forms and instructions are available on the Forms and Publications web page of IRS.gov or by calling 800-TAX-FORM (800-829-3676).
•Information about the Earned Income Tax Credit and how to claim it is also available on IRS.gov.

Undeliverable Refunds

Were you expecting a refund check but didn’t get it?
•Refund checks are mailed to your last known address. Checks are returned to the IRS if you move without notifying the IRS or the U.S. Postal Service.
•You may be able to update your address with the IRS on the “Where’s My Refund?” feature available on IRS.gov. You will be prompted to provide an updated address if there is an undeliverable check outstanding within the last 12 months.
•You can also ensure the IRS has your correct address by filing Form 8822, Change of Address, which is available on IRS.gov or can be ordered by calling 800-TAX-FORM (800-829-3676).
•If you do not have access to the Internet (then I’m not sure how you are reading this…) and think you may be missing a refund, you should first check your records or contact your tax preparer. If your refund information appears correct, call the IRS toll-free assistance line at 800-829-1040 to check the status of your refund and confirm your address.

This line works in Canada but if no one answers after 6 rings, they hang up on you. I swear… I just tried it!

Taxation of Passive Foreign Investment Company

An interesting aspect of foreign investing is the difference in the treatment of foreign investment companies, mutual funds and unit investment trusts as compared to US based mutual funds.

US vs. Foreign

In the US, generally, a mutual fund is treated in a manner similar to a partnership with respect to the income and the gains of the fund.  The income is passed through to the shareholders in proportion to their holdings and reported to the IRS on a form 1099 by the mutual fund.  A copy of the report is also sent to the shareholder to use to prepare his tax return.

Foreign investment companies or mutual funds are not subject to this kind of reporting and disclosure, nor do they want to be.  In the US, the burden is on the shareholder to determine their share of the income of the investment company.  The tax code refers to any kind of corporate mutual fund or investment company outside the US as a passive foreign investment company (PFIC).

US tax laws were set up to deter US persons from investing in mutual funds outside the US, or using a foreign corporation as an investment fund, where the income or gains of the foreign funds are not subject to current taxation, as are the gains and other income of most domestic mutual funds.  For example, if 11 (or more) US persons own equal shares in a foreign corporation, it will not meet the definition of a controlled foreign corporation  and none of the shareholders would be subject to current tax on the income of the foreign corporation, but if that same corporation is also a PFIC, the shareholders will be subject to severe tax treatment on any distributions from the PFIC unless

  • the PFIC elects to be subject to the SEC and the IRS reporting requirements or unless
  • the shareholder elects to pay tax on the undistributed current income of the PFIC (which requires the co-operation of the PFIC) or unless
  • the PFIC is listed on a national securities exchange and the shareholder elects to pay tax on any increase in the market value of the shares from one year to the next.

As a general rule, a US person would be in far better position to invest directly in the stock of foreign corporations that are not PFICs or to invest in a US mutual fund that invests in foreign stocks or foreign mutual funds. In some cases, a US person may be able to utilize a foreign variable annuity or variable life insurance contract to invest in foreign mutual funds, but the tax treatment will be based on the rules for investments in annuities or life insurance rather than for investments in the underlying stocks or mutual funds.

Tax code sections 1291 through 1297 provide the rules for US persons who invest in (PFIC).   According to the tax code, a PFIC is defined as “ … any foreign corporation if 75 percent or more of its gross income is passive income or if 50 percent or more of its assets are assets that produce or are held to produce passive income”.

There are exceptions for bona fide banks, insurance companies and foreign corporations engaged in the securities business – meaning the active marketing of securities.

A PFIC that had elected to be a “foreign investment company”, before December 31, 1962,  is subject to some older rules, which require that;

  1. the company be registered under the US Investment Company Act of 1940, or
  2. it must be engaged primarily in the business of investing or trading in securities and
  3. 50% or more of the total combined voting power of all classes of stock are held directly or indirectly by U.S. persons.

If the foreign investment company elects to distribute at least 90% of its ordinary income, and the shareholders report net capital gains whether or not distributed, the shareholders are not taxed at ordinary income tax rates on their respective share of the earnings and profits of the foreign investment company when their shares are sold or redeemed.  Basically, this will produce the same tax result as owning shares in a US mutual fund.

For companies that had not made such an election before 1963, if a foreign investment company is registered with the SEC, or if it is more than 50% owned by US persons, any gain realized by the shareholders will be treated as ordinary income unless the corporation elects to be taxed in a manner similar to US mutual funds.

If the PFIC isn’t qualified to be an electing foreign investment company or does not choose to do so, the US shareholder may elect to have the PFIC treated as a “pass through entity” – known as a “qualified electing fund” or QEF. If this election is made by the US shareholder, the shareholder must report as income his or her pro rata share of the earnings and capital gains of the QEF for the taxable year. The investor making this election may also elect to delay payment of the tax on the shareholder’s portion of the undistributed earnings of the QEF, but that deferral will be subject to an interest charge. This election is only allowed if the PFIC complies with the IRS information disclosure requirements which will enable the IRS to determine the PFICs ordinary earnings and capital gains.

If the US beneficiaries of a trust investing in a PFIC expect and agree to be taxed on the trust’s income – even though they do not expect to receive any current distributions from the trust, there should be no disadvantage to electing QEF status for every PFIC in which the trust has invested, and indeed there are enormous disadvantages from failing to do so.  If the PFIC is not a QEF for every year in which it is a PFIC, then the conversion from capital gain to ordinary income and the interest charge rules continue to apply to the extent of the company’s earnings while it was a non-QEF.  In other words, only a so-called “pedigreed” QEF which has been a QEF in every year in which it was a PFIC is excused from the interest charge and character conversion rules.  For this reason, a foreign trust agreement should provide that the trustee may not acquire any equity interest in a foreign company that qualifies as a corporation for U.S. tax purposes (unless that company is engaged in the active conduct of a trade or business) without providing notice to any US beneficiaries and their accountants so that the appropriate election to be a QEF can be made in a timely manner.  Furthermore, the trust agreement should provide that this notification requirement must be made applicable to any investment adviser engaged by the trustee to manage any trust assets.

If a PFIC does not agree to be subject to the jurisdiction of the SEC and does not provide the IRS with the annual information the IRS requires for a QEF election, then the shareholders of the PFIC are subject to;

  1. ordinary income tax on  any current distributions from the PFIC,
  2. distributions and dispositions of fund shares deemed to be from prior years earnings of the PFIC are taxed at the highest rate for ordinary income in each prior year and
  3. an interest charge on the deferred distribution.

Distributions in the first year of a PFIC are treated as ordinary income. Future distributions are also treated as ordinary income to the extent that the distributions are no more than 125% of the average distributions for the previous three (or fewer) years.  Thus, planned distributions can be used to minimize the tax on distributions of accumulated income.

Dispositions of PFIC shares by gift, at death or by other means (such as some redemptions) are treated like distributions but are not eligible for the ordinary income tax treatment described above.

The Taxpayer’s Relief Act of 1997 introduced some changes that are intended to eliminate some conflicting and overlapping provisions of the rules applicable to a controlled foreign corporation (CFC) that is also a PFIC.  Basically, a foreign corporation that would otherwise be a PFIC will not also be subject to the pass-through rules for a CFC for the 10% or greater US Shareholders of the CFC. This change is applicable for tax years after 1997. However, where a PFIC is not a QEF (qualified electing fund), any stock held by a US person who owns 10% or more of the stock is either (1) subject to a current tax and an interest charge on the deferred distributions, or (2) is subject to the rules for a PFIC. In addition, if a CFC shareholder ceases to be a 10% shareholder but remains as a shareholder, the shareholder will immediately be subject to the PFIC rules.

Another “simplification rule” in the 1997 law permits US owners of a stock in a PFIC that is traded on a national securities exchange to make a “mark-to-market” election (IRC section 1256) based on the market value of the PFIC shares at the end of each year. However, any gains recognized by the shareholder will be treated as ordinary income and any losses are limited to gains previously recognized. In addition, the IRS has introduced proposed regulations that will make it very difficult for many foreign mutual funds to qualify for the “mark-to-market” election.