By Denise Coombs, CPA, CA, CFP, Parner at Noseworthy Chapman, a DFK Canada Affiliate
As first published in the Spring 2018 DFK Newsletter
On the breakdown of a relationship, the various tax aspects of support payments, legal costs and division of assets are not usually a main priority, however tax should not be ignored.
Child support is not taxable in the hands of the recipient nor is it tax deductible to the payer; however, this treatment differs from that of qualifying spousal support payments. For income tax purposes, an amount is considered spousal support if meets certain conditions. It must be received by a spouse or former spouse in the year either as alimony or other allowance for the maintenance of the taxpayer. It must be received pursuant to an order of a competent tribunal or by written agreement between the parties which is signed and dated by both parties. It must be payable on a periodic basis. And lastly, the parties must be living separate and apart because of a breakdown of the marriage at the time the payments were received and through the remaining year. Certain payments to a third party, while not periodic or at the discretion of the beneficiary of the payments, may be deductible to the payer if the payments are made pursuant to an order or written agreement. It is important to note that payments made prior to an order or agreement are tax deductible if they would otherwise qualify as support payments, they are made in the same year or the previous year and the order or agreement refers to those payments.
Voluntary payments are not deductible.
Support payments not specifically defined as solely for spousal support will be considered child support for tax purposes. If the full amount of child and spousal support payments are not paid, payments are first treated as child support and any remaining amount is treated as spousal support.
Lump sum spousal support payments are generally not tax deductible unless paid by a former spouse or common law partner with respect to qualifying periodic support payments for one or more previous years as set out in a written agreement or court order. If the amount is more than $3,000, it may qualify as a “qualifying retroactive lump-sum payment” and income averaging may be available thereby taxing the amount in the taxation year it was originally owed as opposed to the year it was actually received.
The Canada Revenue Agency has indicated that legal fees to establish, seek an adjustment to, or enforce payment of support payments are deductible, however legal fees related to establishing parental rights and obtaining a divorce are not deductible.
Tax Credits and Canada Child Benefit Payments
A taxpayer may be able to claim an eligible dependent amount with respect to a child if the person is not claiming the married or common law spouse amount, and lives with and supports a child under the age of 18. The taxpayer must not be making any support payments for the child and no one else can claim the credit for that child. If more than one child, each parent may be able to claim the eligible dependent amount in respect of one child if they do not pay support in respect of that child.
A disability tax credit can be claimed by a parent of a child if the tests for the eligible dependent amount are met.
Medical expenses paid by the taxpayer for the child can be claimed, however they cannot be claimed if combined with child support payments.
While the transfer of unused tuition tax credits from a child is sometimes covered in separation and divorce agreements, it is the child who ultimately designates the transfer.
The Canada Child Benefit is generally paid to the individual who is “primarily responsible” for the care of a child who is under the age of 18 and who lives with that individual. The benefit amount is based on the family’s net income, adjusted for certain items. In the case of separated or divorced couples, the benefit amount is calculated based on the adjusted income of the individual who has primary custody of the child. In a shared custody situation where a child lives with two different individuals in separate residences on a “more or less equal basis”, each individual will receive 50% of the payment they would have received if the child lived with them all of the time.
Tax-Effective Division of Matrimonial Assets
A balanced after-tax segregation of matrimonial assets may be difficult to achieve as not all assets are being liquidated and it may be that the assets which one spouse may want to liquidate, such as private company shares, may have an unrealized tax liability associated with them that must be considered.
The Income Tax Act provides that assets can be transferred between spouses on a tax-deferred basis such that no capital gain is triggered on the transfer where assets are being moved as part of a settlement of rights arising out of a marriage or common law partnership. As part of the negotiation of the division of assets it should be kept in mind that the recipient spouse will pay tax on any accrued gain or capital cost allowance recapture when they ultimately dispose of the property.
Common examples of these types of assets would be the family cottage, investments with unrealized gains and rental properties.
Certain assets, such as cash, a principal residence, and investments and personal assets with no unrealized gains, can be transferred at fair market value because no taxable gain will result. In the case of a principal residence, the parties will need to designate a property as a principal residence for specific years and if there is more than one residence, they will need to decide which to designate. If they cannot agree on designation, income tax may be applicable.
No tax is triggered on a transfer directly between RRSPs and RRIFs provided both parties sign the necessary forms, the transfer is made while the parties are living separate and apart and the transfer is pursuant to a court order or separation agreement. A transfer of Registered Pension Plan (RPP) benefits can also take place on a tax-deferred basis if the transfer is between RPPs or to an RRSP. Amounts can transfer directly between Tax-Free Savings Accounts without affecting either party’s contribution room.
Once Service Canada is notified of a divorce, CPP credits are combined and split between former spouses however Quebec, Saskatchewan, BC and Alberta allow parties to opt out of this equalization.
A division of other assets such as stock options, convertible securities, foreign assets and shares of private corporations may be more difficult to accomplish. Shares of private corporations may be particularly hard to deal with as the value of the shares may be such that equalization can only be partially achieved using other marital assets and financing is required to complete the equalization. Where both spouses are shareholders of the corporation, the parties must agree as to whether both will continue with the business, whether one spouse will buy the shares of the departing spouse or have the company redeem the shares, or whether the business will be split such that each spouse will continue to operate their own business.
The Income Tax Act contains a provision that allows for the splitting of corporate assets held by one company into two companies, perhaps one owned by each of the former spouses. This can be accomplished on a tax-deferred basis while the individuals are still spouses and therefore must be completed before the divorce is finalized.
In finalizing your separation and divorce, tax is not always top of mind. Good advice from your accountant prior to, and during the separation process can result in significant tax savings and asset preservation.
By Christie Roberts, CPA, CGA, Senior Tax Analyst at Davis Martindale, a DFK Canada Affiliate
As first published in the Spring 2018 DFK Newsletter.
When you change the use of an asset, from income producing to personal use, or vice versa, there is a deemed disposition on the date that the change of use occurred. This will result in a capital gain or loss on the property realized from the date of purchase until the date of the deemed disposition. This deemed disposition applies if you choose to convert a property from your principal residence to a rental property, or vice versa. When converting from a principal residence to a rental property, the deemed disposition may not have an effect on your tax situation if you are able to claim the principal residence exemption. However, when converting a rental property to a principal residence, the capital gain could result in significant taxes owing with no funds generated to pay those taxes.
Luckily, there are elections available under subsections 45(2) and 45(3) of the Income Tax Act that allow a deferral of the capital gain until the year in which the property is actually sold. These elections also allow a four-year extension to the period for which the principal residence exemption can apply to the property. The election to defer the gain on a rental property converted to a principal residence has to be filed with your income tax return for the year in which the property is ultimately sold. The election cannot be made if any capital cost allowance was claimed in any year against the rental income.
The election to defer the gain on a principal residence converted to a rental property has to be filed with your income tax return for the year in which the change of use occurs. Once the election has been made, no capital cost allowance may be claimed on the property. If a claim for capital cost allowance is made in a future year, the election will be automatically rescinded. If your return will be electronically filed, you can file the election by writing a letter indicating your intention to use the election and sending it to the Tax Centre that processes your income tax return. This letter should be sent prior to the due date of your income tax return for the year.
Regardless of the above elections that extend the period for the eligibility of the principal residence exemption, remember that only one property can be claimed under the exemption for each taxation year. Therefore, while you may able to claim the principal residence exemption for one of the years that the property was a rental property, you will lose the ability to use the exemption on any other properties for that year. The extension of time to claim the principal residence exemption is exceptionally beneficial if you rented your home, or lived in a retirement or nursing home, while the property was rented.
The Small Business Investment Grant helps Prince Edward Island’s small businesses improve efficiency and innovation by way of a non-repayable financial contribution toward eligible capital asset costs.
The P.E.I. government introduced the Small Business Investment Grant in its 2018 budget. This new 15% rebate on up to $25,000 of qualifying capital investments in the improvement of a business will save an eligible business up to $3,750.
Eligible capital assets must be purchased between April 6, 2018, and March 31, 2019 from an arm’s length supplier. An application can include the purchase of multiple qualifying assets up to the $25,000 threshold. If a business receives non-repayable support from any other program for the purchase of an eligible asset, then that asset will not qualify for the grant.
The grant is available to unincorporated and incorporated businesses operating on P.E.I. The business must be registered federally or provincially. The business must have at least one employee (minimum of 560 hours) or it must be the primary source of income for the applicant. A person who owns or controls multiple qualifying businesses can only receive a grant for one business per year. A business that is eligible for this grant and for Innovation PEI’s Capital Acquisition program may only apply to one program per year.
The following types of business are not eligible for the grant; fishers, farmers, not-for-profit organizations, banks and financial companies, realty businesses (including landlords and developers), professional services business, and consulting services business.
Subject to approval by Innovation P.E.I., the reasonable and proper costs of a capital asset will be eligible for the grant. The following costs are specifically excluded.
- allocated cost or value of goodwill;
- any portion of the cost of an asset that, in the opinion of Innovation PEI, exceeds the fair market value of the asset;
- HST or any other federal or provincial tax which may be eligible to be fully or partially refunded;
- intangible assets;
- development costs;
- speculative land acquisitions;
- vehicle acquisitions; and
- capitalized carrying costs.
The application for the grant must be submitted to Innovation P.E.I. through their on-line application system at https://cloud.garago.net/?siteid=innovationpei The complete terms and conditions of the grant are available at https://cloud.garago.net/terms.cfm Innovation P.E.I. staff are available to assist with the application process.
There is a limited budget for the grant. Applications for the grant will be processed on a first come first served basis. An application for the grant will not be considered received until all required information is submitted.
P.E.I. 2018 Budget
On April 6, 2018, Honourable Heath MacDonald, Minister of Finance presented the Prince Edward Island budget for 2018-19. The budget includes reductions to personal income tax and corporate income tax, a sales tax rebate, an increase in bursaries for Island post-secondary students, and additional help repaying student loans for students who reside on P.E.I. after they graduate.
Personal Income Tax
The Basic Personal Amount is the amount that Islanders do not have to pay P.E.I. income tax on. The Basic Personal Amount is increasing by $500 for 2018, and for 2019. The new Basic Personal Amount will be $8,560 for 2018 and $9,160 for 2019. This change will save Islanders $49 in 2018 and $98 in 2019 compared to their 2017 income tax.
The Spouse/Common Law Spouse tax credit and Eligible Dependent/Equivalent to Spouse tax credit give a tax savings to Islanders whose spouse or eligible dependent has no income or low income. The base used to calculate these P.E.I. tax credits is also increasing for 2018 and 2019. The increase will be proportionate to the increase in the Basic Personal Amount.
Corporate Income Tax
The P.E.I. corporate tax rate for income eligible for the small business deduction will be reduced by 0.5% from 4.5% to 4.0% for this fiscal year. The reduction will be prorated if a company's taxation year straddles the effective date of the change. A company whose taxation year starts on or after the effective date will be able to save up to $2,500. A further unspecified reduction in the small business tax rate was promised for the future.
In the budget address, the Minister said: "The dividend tax credit will also be adjusted to preserve the integration between the corporate and personal income tax systems." This means that the personal income tax rate on dividend income will be increased so that the total corporate and personal income tax collected on income earned through a company remains roughly the same as it was before the reduction in the small business tax rate.
Beginning on May 1, 2018, eligible Island businesses will be able to apply for the new Small Business Investment Grant. This new 15% rebate on up to $25,000 of qualifying investments in the improvement of a business will save an eligible business up to $3,750. Details of who will be eligible and what types of expenditures will qualify are expected to be released soon. You can find additional information about the grant on the Province's website as it becomes available.
A new Clean Energy Price Incentive will begin on July 1, 2018. It will be a point of sale rebate equivalent to the provincial portion of the HST. It will apply to the first block of residential electricity (the first 2,000 kwh consumed per month), firewood, wood pellets, and propane. The Province estimates average annual savings on residential electricity of $120 per household. Households with high electricity consumption (e.g. homes with heat pumps) could save up to $25 per month.
Support for Island Students
Island students earning their first degree at UPEI or Maritime Christian College, or their first diploma at Holland College or Collège de l’Île will be eligible for the new Island Advantage Bursary. Students completing a four-year degree will receive up to $3,600 during their studies. Students completing a two-year diploma will receive up to $1,200. This is in addition to the amounts they are eligible to receive under the existing George Coles Bursary, Island Student Award, Island Skills Award, and George Coles Graduate Bursary.
Additional support will be available to Island students who have a greater financial need. A student attending a P.E.I. publicly-funded post-secondary institution who meets the income requirements for the Canada Student Grant will be eligible for an additional Island Advantage bursary.
Island students are eligible for a grant of up to $2,000 per year of study towards the repayment of their P.E.I. student loans under P.E.I.'s existing Debt Reduction Grant Program. Beginning with the 2018-19 academic year, Island students who reside in P.E.I. within three years of graduation will be eligible for up to $1,500 per year of study of additional grants.
The Province continues to negotiate with the Federal government on a framework for the taxation of cannabis, and a carbon plan to deal with the Federal government's intention to implement carbon taxes in all provinces and territories.