The alternative minimum tax (AMT) is a tax system that ensures high-income individuals pay a minimum amount of tax, especially those who benefit from certain tax incentives and deductions that reduce the tax they owe to very low levels.

The Canadian federal government has proposed significant alternative minimum tax changes in the 2023 Federal Budget. These changes could have implications for high-income individuals who receive income from tax-preferential sources or have significant deductions that reduce their tax liability under ordinary tax rules.

In this article, we will explore the key changes proposed in the 2023 Federal Budget regarding the alternative minimum tax and how they could impact individuals. We will delve into the details of these changes, discuss who they will affect, and provide insights on how individuals can navigate the new AMT rules. For purposes of this article, we will only focus on the federal alternative minimum tax but some provinces also impose a provincial AMT, which could increase the tax payable under AMT even further.

 

What is the Alternative Minimum Tax?

The alternative minimum tax is an alternative tax calculation system designed to ensure that high-income individuals pay a minimum amount of tax. The AMT is calculated on "adjusted taxable income," which is determined by making specific adjustments to the taxpayer's regular taxable income. As such, a parallel tax calculation is used that allows fewer tax deductions, exemptions, and credits than under the regular income tax calculation. As a result, it can result in a potentially higher tax liability for individuals subject to its provisions.

Generally, if the tax calculated under the AMT system is more than the amount calculated under the regular tax system, the difference is the alternative minimum tax owing for the tax year. If the AMT surpasses the regular income tax, any extra tax paid can be carried forward for up to seven years to offset regular tax to the extent that regular tax exceeds AMT in the carryforward period. Essentially, this allows individuals to view the AMT as an advance payment of taxes that can be recovered within a seven-year timeframe.

Under the current alternative minimum tax system, the tax rate is a flat 15%, and individuals are granted a standard exemption of $40,000.

Proposed Changes to the Alternative Minimum Tax

The 2023 Federal Budget proposes significant changes to the alternative minimum tax regime. These changes aim to address perceived inequities and ensure a fairer taxation system for high-income individuals. Let's explore some of the key changes proposed in the budget and their potential impact:

Increase in AMT Exemption and AMT Rate

The budget proposes increasing the AMT exemption from $40,000 to $165,430 for 2023 and $173,000 for the 2024 taxation year. The exemption would also be indexed to inflation. Due to the increase in the exemption amount, very few Canadians will pay AMT and even high-income Canadians may not pay AMT if their only source of income is fully taxable employment, professional, or business income.

However, despite the increase in the exemption, the budget also proposes raising the AMT rate from 15% to 20.5% of adjusted taxable income. These changes aim to strike a balance between providing relief for some taxpayers while ensuring a fairer tax system overall.

Broadening the AMT base

Several revisions are proposed in order to expand the AMT base by placing additional restrictions on tax preferences such as exemptions, deductions, and credits. The key changes include:

1. Changes to Capital Gains and Losses - under the proposed changes, the capital gains inclusion rate has increased from 80% to 100% for purposes of calculating AMT adjusted taxable income. This change could result in a higher AMT liability for individuals who receive a significant portion of their income from these sources.

At the same time, capital loss carry-forwards and allowable business investment losses have been decreased from 80% to 50% deductible for AMT purposes. This change would limit the offsetting of AMT liability through the utilization of capital losses and business investment losses. Let's look at an example to see how these changed would impact the AMT calculation from current to proposed rules.

Example:

In the following example, let's assume an individual will sell qualifying small business shares in 2024, that will qualify for the lifetime capital gains exemption (LCGE). The fair market value of the private company shares is $900,000 with a nominal adjusted cost base. In addition, the taxpayer will also sell other capital property with a fair market value of $600,000 with an adjusted cost base of $200,000, resulting in a capital gain of $400,000. In addition, the taxpayer has a net capital loss carryforward of $100,000 from a prior year.

As shown above, under the current rules, the taxpayer's minimum tax is $40,935 (amount in excess of regular tax) but the new AMT rules increase the taxpayer's minimum tax to $63,820.

2. Employee Stock Options Benefits - the proposed changes include 100% of employee stock option benefits in the calculation of adjusted taxable income for AMT purposes. Currently, only 50% of employee stock option benefits are included.

Example:

Let's assume that an employee exercises options to acquire publicly listed shares at an exercise price of $100,000 when the fair market value of the shares is $500,000, which means the stock option benefit is $400,000. Further, let's assume that these options qualify for the stock option deduction.

As shown above, under the current rules, the taxpayer's minimum tax is nil as the tax calculated under the regular tax is higher. However, under the new rules, AMT is $2,302.

3. Donations of Publicly Listed Securities - for donors making in-kind donations to registered charities of shares, the proposed changes will include 30% of the capital gains on these shares in the calculation of the adjusted taxable income for AMT. Currently, there is zero inclusion of these gains in the calculation of the AMT.

4. Deductibility of Non-Refundable Tax Credits - most non-refundable tax credits, which are currently fully deductible, would become 50% deductible. These changes could result in a higher AMT liability for individuals who rely on non-refundable tax credits to reduce their tax liability.

5. Disallowing Various Deductions - currently, most deductions are allowed in the calculation of the adjusted taxable income for AMT. The new rules under alternative minimum tax propose that the following deductions would be 50% disallowed. These include:

• interest and carrying charges incurred to earn property income;
• deduction for limited partnership losses of other years;
• non-capital loss carryovers;
• employment expenses (other than those to earn commission income);
• moving expenses; and
• childcare expenses.

For a complete list of deductions that are now disallowed at 50%, refer to the link at CRA's website.

Who Will Be Affected by the Alternative Minimum Tax Changes?

The proposed changes to the alternative minimum tax will primarily affect high-income individuals who receive income from tax-preferential sources or have significant deductions that reduce their tax liability under ordinary tax rules. Individuals who fall into the following categories may be particularly impacted:

1. High-income individuals: Those with substantial income from capital gains, employee stock options, or dividends may experience an increase in their AMT liability due to the proposed changes. The revised AMT regulations lead to a higher federal rate applicable to capital gains, which might come as a surprise to individuals who experience substantial gains on their investments in a given year, especially considering that any AMT owed may become permanent if not recovered within the following seven years.
2. Taxpayers with significant deductions: Individuals who rely on deductions such as capital loss carry-forwards, allowable business investment losses, or non-refundable tax credits to reduce their tax liability may see a reduction in their ability to offset AMT liability under the proposed changes. While all capital gains are fully taken into consideration when calculating the proposed AMT, only half of any carried-forward losses from previous years will be accounted for. As a result, there may still be residual income subject to AMT requirements when the prior year's investment losses are used to offset current-year capital gains. Individuals who have unused net capital losses from earlier years should consider utilizing those losses this year (i.e., before the new AMT regulations take effect).
3. Donors of publicly listed shares: The regular tax rules currently allow for the elimination of capital gains on donations of publicly listed securities. This promotes the donation of easily convertible securities by the recipient. However, under the proposed computation rules for AMT, 30% of capital gains from such donations would be considered in the AMT computation. This could lead to unexpected outcomes when donating publicly listed securities, especially since only 50% of charitable tax credits may be taken into account. These changes might discourage individuals from making such donations.

As noted above, the proposed changes to the alternative minimum tax system will have various implications for affected individuals. Hence, it is essential for taxpayers to assess their potential AMT liability under the proposed changes to ensure accurate tax planning and compliance. For example, business owners who are considering tax planning strategies to generate a significant capital gain after 2023 should carefully evaluate the potential consequences of these proposals with their tax advisor. Likewise, individuals who are contemplating making substantial donations to registered charities need to assess how this will affect the AMT under both the current regulations and the proposed changes.

The proposed changes to the AMT computation rules would come into force for taxation years beginning in 2024.

Conclusion

The proposed changes to the alternative minimum tax in the 2023 Federal Budget aim to ensure a fairer taxation system for high-income individuals. The inclusion of additional income sources and deductions, along with changes to the exemption and rate, could result in a higher AMT liability for some taxpayers.

It is crucial for individuals who may be affected by the new AMT rules to stay informed and seek professional advice to understand the implications and plan their tax strategies accordingly. By working with qualified tax accountants, individuals can navigate the changes effectively and optimize their tax positions. If you are looking for an accountant in Hamilton for professional guidance, contact us today. We are here to help!

If you want to learn more about other tax and accounting topics, explore the rest of our blog!

Investing in rental properties can be a lucrative venture, providing a steady stream of income and potential long-term wealth. A common question that often arises with clients is how best to structure their real estate investments. Though there are a few different structures available to hold your real estate investment, but for the purposes of this article, we will focus on holding real estate personally or through a corporation.

Within a corporation, the real estate properties can be held either in an existing operating company, a holding company, or a property company. Ultimately, which structure is best for you depends on your individual situation and long-term goals for your real estate investments. Most investors prefer using a holding company to buy real estate in Canada; the reasons of which will become apparent below.

In this article, we will explore the advantages and potential drawbacks of holding real estate personally and through a corporation via a holding or operating company. In addition, we will also discuss other important considerations that need to be taken into account before making a decision on which structure is best for you.

Holding Real Estate Personally

Holding real estate personally can be quite beneficial for those who are looking to keep their investments simple.

If your objective is to own a few real estate properties, the simplest structure for you would be hold the property personally. In this situation, you would purchase the property in your name or in joint ownership with your spouse and obtain financing personally. You would report the gross rental income on your personal tax return and claim the corresponding eligible rental expenses to arrive at your net profit from the rental property. To get a full list of eligible expenses that can be claimed against your rental income, see our article, Tax on Rental Income in Canada: A Comprehensive Guide.

In addition, when you own the rental property personally, the other tax obligation you need to be aware of is the capital gain tax in the year you dispose of the property, which would get taxed based on your personal marginal tax rate.

The main advantage of holding real estate personally is that it allows you to keep costs low as you won't have to pay for the setup, filing, and maintenance costs associated with a corporation. Additionally, you will have more control over your investment decisions and can manage it yourself or hire a property manager if desired. Furthermore, if you are looking to quickly liquidate your investment and move on to another opportunity, then holding real estate personally may be the best option for you. Finally, holding real estate personally can provide you with more flexibility in obtaining financing and in certain cases may be more tax advantageous as rental losses can be used to offset your other taxable income.

On the other hand, there are some potential drawbacks to consider. For instance, holding real estate personally exposes you to a greater risk of liability if any legal issues arise. This means that your personal assets are at risk in the event of a lawsuit or other legal issue. Additionally, if you have multiple properties, then the income from each property will be reported on your personal tax return and can result in a higher overall tax burden than if they were held through an entity.

Overall, there are both advantages and disadvantages to holding real estate personally so it is important to carefully consider all of your options before making a decision. It is always best to consult with a qualified tax professional who can help you determine the best structure for your specific situation.

Holding Real Estate Within a Corporation

If you plan to be in the business of real estate investing by purchasing multiple properties in the future, you’ll want to consider holding the properties within a corporation. The most important benefit of holding real estate within a corporation is liability protection. Furthermore, as your investment portfolio grows, having a corporation allows for greater flexibility when it comes to tax planning and tax savings, helping you maximize your profits. Below we will compare the advantages and disadvantages of holding real estate through an investment holding company vs an operating company.

Using a Holding Company to Buy Real Estate in Canada

A holding company is a separate legal entity that does not carry on any business activities. It does not participate in the selling of goods or the provision of services. Instead, its main function is to maintain investments, which can include real estate properties or shares in both public and private companies. In the context of private companies, a holding company is usually introduced to hold shares in an operating company for tax planning purposes.

An operating company is an active company used to run the day-to-day business operations of a business. If an operating company is under the control of a holding company, it is classified as a subsidiary.  The main advantage of such a structure, where the holding company owns the operating company, is that it allows you to shift residual income from the operating company up into the holding company on a tax-deferred basis via dividends. This provides the holding company with enough cash to acquire passive assets or flow the funds to the individual shareholder(s).

Though this type of structure can provide many tax benefits but the most important is that it allows you to defer personal liability until you withdraw the funds for personal use from the holding company. For the purpose of this article, we will be analyzing the advantages and disadvantages of a holding company that owns only investment property such as real estate, shares of publicly traded shares etc, rather than shares of an operating company.

Advantages

1. Limited Liability Protection

One of the key advantages of holding a rental property through an investment holding company is the limited liability protection it provides. When you hold property in a holding company, your personal assets are safeguarded in the event of a lawsuit or other legal issues. This means that in the case of a legal dispute such as a tenant suffering an injury on your property, your personal possessions like your house, car, and other belongings would be safe from any potential risk in the lawsuit. However, it is essential to note that severe negligence or illegal activities may still expose you to personal liability.

For some investors, limited liability protection alone would be the guiding factor of whether they should incorporate a holding company to hold their real estate investments. For example, for commercial real estate investors, having limited liability protection on commercial property that is rented out is even more important as they have a higher risk liability compared to a residential rental property.

2. Estate Freeze

Another advantage of incorporating an investment holding company is the ability to do an estate freeze as part of a tax planning strategy. This strategy allows you to “freeze” a company’s value at a point in time for the original shareholders while ensuring that any future appreciation on the assets held in the holding company are passed to the next generation or desired family members. If your goal is to expand a substantial investment portfolio and would like to reduce your estate taxes while transferring property to your family, utilizing an investment holding company structure can provide maximum flexibility.

Disadvantages

1. Increased Costs and Administrative Responsibilities

Holding companies are simply expensive to set up and have ongoing administrative responsibilities. This includes the initial setup of a corporation, such as incorporation fees, name search fees, and professional fees.  Once the holding company is established, there are ongoing annual fees for maintaining corporate records and filing corporate tax returns. These costs can vary depending on the complexity of your rental property and the specific services required.

Regardless of whether you choose to incorporate or not, it is essential to maintain accurate financial records and properly report rental property income and expenses on your tax return. While accounting for a corporation can be more complex, consulting with a corporate tax accountant can ensure compliance and optimize tax strategies.

2. Tax Implications of owning property in an investment holding corporation

When it comes to tax implications, owning a rental property in a corporation does not always provide significant tax benefits. Unlike personal taxes, there are no graduated tax rates or brackets applied to an investment holding company. In Canada, passive income earned by corporations is subject to a single high tax rate. For example, in Ontario, the corporate tax rate on passive income such as rents, interest, and dividends is 50.2%. This tax rate often aligns with the personal marginal tax rate for individuals in the highest bracket.

However, when the holding company distributes taxable dividends to its shareholders, a portion of the taxes paid can be refunded through a mechanism called Refundable Dividend Tax On Hand (RDTOH). Once the dividend is declared, it reduces the corporate tax rate (to the extent of the dividend) to 20% which is relatively low. Therefore, it is advisable for an investment holding company to distribute its income to shareholders in the same fiscal year it was earned in order to minimize the overall amount of corporate taxes paid for that year. Let's look at an example to see how taxable income is taxed in an investment holding corporation.  

Example

Assume the corporation is a Canadian Controlled Private Corporation (CCPC) and earned $10,000 of rental profit in the year. The corporate tax rate for a CCPC on passive income is 50.2% in Ontario compared to only 12.2% on active business income.

Taxation of investment income (rental) within an investment holding company

Taxable income	$10,000
Corporate Tax payable (50.2%) - A	$5,020
After-tax cash available	$4,980

Calculation of RDTOH

Taxable income	$10,000
RDTOH (30.67% of taxable income)	$3,067

In order for the corporation to receive part of the corporate tax paid back through the RDTOH, the corporation has to pay the shareholder a dividend. To get the full $3,067 back, the total dividends paid must be $8,001 based on the refundable dividend tax rate of 38.33% for CCPC's.

Dividends paid to shareholder	$8,001
Refundable Tax ($8,001 *38.33%) - B	$3,067
Net tax at the corporate level (A-B)	$1,953

Personal tax paid on dividends flowed out to the shareholder

Assuming that the shareholder is in the highest personal tax bracket, the non-eligible dividend rate for Ontario is 47.74%.

Taxable dividend	$8,001
Personal tax payable (47.74%) (C)	$3,820
After-tax cash available to shareholder	$4,181
TOTAL PERSONAL AND CORPORATE  TAX – 57.73% (A-B+C)	$5,773

As the example above shows, you will generally pay a higher tax on passive income earned through an investment holding company than if you earn such income personally. Therefore, owning a rental property personally rather than corporately is a better option for many people. This approach allows them to pay lower taxes while avoiding the complexities and expenses associated with managing a corporate structure.

However, certain strategies can help minimize the tax burden associated with owning rental properties in a corporation.  One such strategy is depreciation, also referred to as capital cost allowance. This allows for a deduction of a percentage of the building's cost annually, which helps defer the tax consequences associated with rental income. By carefully calculating and claiming capital cost allowance, it is possible to lower yearly income tax until the property is eventually sold. To learn more about how capital cost allowance works in the context of rental properties, read our blog article, Tax on Rental Income in Canada: A Comprehensive Guide.

3. Lifetime Capital Gains Exemption

The Lifetime Capital Gains Exemption (“LCGE”) allows every eligible individual to claim a capital gains deduction of up to $971,190 realized on the disposition of their qualified small business corporation shares (“QSBCS”). In order to qualify for this deduction, the small business corporation must meet certain criteria. It must be considered a Canadian-controlled private company and generate its income primarily through active business activities within Canada.

An investment holding company that is only used to hold passive assets will not qualify for the enhanced capital gains deduction when its shares are sold. Unfortunately, this is a common misconception among real estate investors that they can take advantage of the lifetime capital gains exemption on the disposition of the investment holding company’s shares.

Using an Operating Company to Buy Real Estate in Canada

Advantages

1. Cost Savings

The main advantage of owning real estate within an operating company is the potential cost savings that come from not having to establish and maintain a second separate entity. This could be particularly significant for smaller, less complex businesses. However, if a business has substantial size or growth prospects, it may be worthwhile to consider this investment.

Disadvantages

1. Asset Protection/Limited Liability Protection

Owning real estate in an operating company may seem like a convenient option, but it actually comes with some risks. Unlike holding companies, operating companies are exposed to various risks through their everyday business activities. This means that if something unfortunate happens to the operating company, the assets, including the real estate, could be vulnerable to creditors.

By transferring some of the assets from the operating company to a holding company, you can create a protective layer for those assets. This means that even if your operating entity gets sued, the real estate assets will remain separate and protected from any legal proceedings. Hence from the perspective of limited liability protection, owning real estate in an operating company carries far more liability.

2. Ease of Exit

Generally, when you go to sell your business, buyers are more interested in the primary operating portion of your business than its investments. However, complications may arise if both are housed within the same company and a potential buyer expresses interest in only the operating portion. In such cases, transferring the real estate or passive assets to another entity becomes necessary, which requires tax planning and takes considerable time. 

Also, it is important to note that having passive assets in an operating company could make you ineligible in meeting the criteria for the capital gains exemption on the sale of the operating company’s shares. Hence proper tax planning and the right structure is imperative to ensure you can utilize the capital gains exemption and other benefits when you're ready to exit the business.

Other considerations

Mortgage Financing

Before incorporating your rental property, it is crucial to verify the criteria for financing properties owned by corporations. It may be more difficult to secure mortgage financing for a corporation compared to buying a property personally. Additionally, when applying for a mortgage as a corporation, banks may require personal guarantees from the property owners, particularly if the business is not well-established. This negates the purpose of setting up a holding company for limited liability protection. Understanding these restrictions and requirements is vital to ensure a smooth purchasing process.

Principal Residence Exemption

One of the primary considerations when deciding whether to incorporate your rental property is the potential impact on the principal residence exemption. This exemption allows individuals to sell their primary residence without incurring capital gains tax. If your rental property is part of your principal residence, incorporating may jeopardize your eligibility for this exemption. Unless you have sophisticated tax planning strategies in place, it is generally not advisable to incorporate a rental property that is part of your existing home.

Conclusion

In conclusion, deciding whether using a holding company to buy real estate or investing in real estate personally will ultimately depend on your long-term investing goals. It is important to understand the implications of each structure and how it affects your overall tax liability. Understanding the specific circumstances of your rental property and seeking professional advice from accountants and lawyers specializing in real estate tax planning is crucial in making an informed decision.

With proper research and careful consideration, you can make an informed decision that best fits your financial goals. If you have additional questions on how best to structure your real estate investments and are looking for an accountant in Hamilton for professional guidance, contact us today. We are here to help!

If you want to learn more about other tax and accounting topics, explore the rest of our blog!

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Disclaimer

The information provided on this page is intended to provide general information. The information does not take into account your personal situation and is not intended to be used without consultation from accounting/tax professionals. NBG Chartered Professional Accountant Professional Corporation will not be held liable for any problems that arise from the usage of the information provided on this page.

Are you unsure whether you should classify someone as an employee or a contractor? The Canada Revenue Agency (CRA) has specific guidelines that determine the distinction between the two. Understanding these guidelines is crucial for businesses to ensure compliance and avoid potential penalties. In this article, we will delve into the differences between an employee and a contractor and the key factors used by the CRA to determine employee vs contractor status. By the end, you will have a clear understanding of the factors that determine a worker's employment status, the rights and responsibilities associated with each, and the implications for both employers and workers.

Whether you're an employer looking to hire or a worker seeking clarity on your employment status, this article will provide you with valuable insights to navigate the complex world of worker classification in Canada. So, let's dive in and unravel the intricacies of employee vs contractor differences!

Definition and differences between an employee vs contractor

You are probably familiar with the terms "employees" and "contractors," but you may not fully understand the distinctions between them. These two categories of workers are mutually exclusive, which means that an individual cannot simultaneously be both an employee and a contractor for the same employer. Moreover, there are significant practical differences between these two worker classifications that have implications for both the worker and the business. We will look at the differences between employee vs contractor from both the worker's perspective and also the employer's perspective.

Contractor

In contrast to employees, contractors are individuals who provide services to clients under a contract for services. Contractors are considered to be in business for themselves and as such they are responsible for their own taxes, income reporting, and expenses.

The advantages of being a contractor include:

• Contractors have more autonomy and control over how the work is carried out.
• They also have more freedom in setting their own rates, hours worked, and job tasks than employees do.
• Contractors do have an opportunity to make more profit.

The disadvantages of being a contractor include:

• Contractors do not receive benefits or are protected by employment standards legislation.
• Contractors assume greater financial risk.

From the employer's perspective, as contractors are not entitled to benefits, the employer is not responsible for payroll deductions such as income tax, CPP contributions, and EI premiums. Additionally, the employer is not required to provide vacation pay or statutory holidays to contractors. For these reasons. employers sometimes prefer hiring contractors instead of employees as they can save costs associated with these obligations. Contractors also provide employers with a more flexible workforce, as they are able to hire and terminate contracts easily compared to employees.

Employee

An employee, as defined by the CRA, is an individual who performs services for an employer under a contract of service.

The advantages of being an employee include:

• Employees typically have a long-term relationship with the employer and are entitled to benefits such as vacation pay, sick leave, and pension contributions.
• Employees are protected by Employment Standards Legislation, which includes minimum wage laws, overtime pay, and protections against wrongful dismissal.
• Employees are entitled to the employer portion of the Canada Pension Plan (CPP) and Employment Insurance (EI) benefits.

The disadvantages of being an employee include:

• The employer has a great deal of control over the employee's work, including how, and when the work is performed.
• Employees are typically expected to work a specific number of hours per week and adhere to established policies and procedures set by their employers.
• Employees don't have an opportunity to share in the profits of the business and instead are paid based on a fixed salary.

In the context of an employer-employee relationship, the employer has an obligation to deduct the appropriate payroll deductions from the gross pay of the employee. This includes income tax, Canada Pension Plan (CPP) contributions, and Employment Insurance (EI) premiums. In order to comply with regulations, employers are required to send both the deducted amounts and the employer's portion of CPP contributions and EI premiums to the CRA. The employer is also responsible for providing vacation pay and statutory holidays, as well as any other benefits specified in the contract of employment.

Factors to determine employee vs contractor status

Determining whether someone is an employee vs contractor is not always a straightforward task. It involves considering several factors that contribute to the nature of the work relationship.

Based on CRA guide on Employee or Self-employed, the first step in determining whether a person is an employee or a self-employed individual is the intention of the parties. While the actual working arrangements may differ from the initial intent, understanding the intentions at the outset can provide valuable insights. According to CRA, both parties should have a clear understanding from the onset of whether they intended to establish an employer-employee relationship or a business relationship.

The parties' intentions can be determined through either a written contract or a verbal agreement. In some cases, the intention is evident and both parties are in consensus, thus establishing a shared intent. However, there are instances where the two parties have differing interpretations regarding the nature of their working relationship, resulting in the absence of a common intent.

The second step is to evaluate the relationship between the parties. Hence the central question CRA addresses in this step is:

Is the person performing services as an independent contractor or as an employee?

The purpose of this step is to determine if the actual relationship is consistent with the intent. To answer this question, CRA looks at the following key factors to determine whether you are an employee or an independent contractor:

Control

This factor looks at the degree of control held by the payer and the payer’s right to exercise control over how and when the work is performed. For an employee, the payer has direct control of how and when the work is performed. For example, they may dictate the methods, provide detailed instructions, and closely monitor the progress.

In contrast, contractors have more autonomy and independence in deciding how and when to carry out their work. In addition, they have the ability to accept or refuse work from the payer as well as the right to provide their services to different payers at the same time.

Ownership of tools and equipment

This factor considers the significance of the investment in the tools and equipment by the worker or the payer to accomplish the work. Employers usually provide employees with the necessary tools and equipment to perform their job while retaining the right of use over the tools and equipment.   In certain cases, the employee may have to provide their own tools but courts have acknowledged that this itself does not mean the worker is self-employed.

Contractors on the other hand are responsible for providing their own tools and equipment, and they retain ownership and control over them. They are also responsible for the repair, maintenance and insurance.

Degree of financial risk

This factor primarily focuses on the degree of financial risk taken by the employee. As an employee, you typically do not bear the financial risk associated with the business. Employees receive a fixed salary or wages and are not directly responsible for any operating expenses or losses the employer may incur. Lastly, the working relationship between an employee and employer is continuous.

Contractors, on the other hand, take on significant financial risk and bear the risk of losses. Their income may vary as they have fixed operating costs relating to the operation of their workspace and hiring third parties to help with the work.   Compared to an employee, the working relationship between a payer and contractor is limited to a specific job rather than being an ongoing relationship.   

Opportunity for profit

An evaluation of the level at which an employee can control his or her income and expenses.  Employees generally have limited opportunities to earn more than their fixed salary or wages. They don’t share in the profits or incur the losses associated with the business.

Contractors, on the other hand, often have the opportunity for increased profit. Their income may vary based on the success of their work, and they are able to negotiate higher fees for certain tasks or projects if they are successful in delivering them. This provides them with a greater incentive to perform well.

Degree of responsibility for investment and management

This factor considers the degree of responsibility for investment held by the worker. Generally, employees do not have to make any investment to provide the services to the employer.      

In contrast, contractors typically have to make significant investments to provide the services. This could entail hiring staff and paying third parties to provide the business.  

Subcontracting work 

This factor looks at whether the worker has the authority to subcontract work or hire assistants. Employees typically cannot subcontract their work or hire assistants and thus have to perform the services personally.

Contractors have the freedom to hire other parties to do the work and the payer has no control over who they hire.  This gives contractors more flexibility in managing their own business operations and allows them to expand their services without relying on the employer.

Ultimately, it is important to consider all relevant factors in order to determine if an individual is an employee vs contractor. Based on CRA guidance, the significance of each factor will vary based on the specific facts and circumstances of each case. No single factor can singularly define the employment connection. Instead, CRA analyzes each factor as part of the larger scenario to ascertain the overall nature of the relationship between the worker and the payer.

Frequently Asked Questions

Are subcontractors considered self-employed in Canada?

Yes, subcontractors in Canada are considered self-employed. As a result, they are required to remit their own taxes, such as income tax and HST. In addition, they need to file their T1 personal tax return and report their income on Form T2125 and claim all their eligible business expenses.

How to pay taxes as an independent contractor in Canada?

As an independent contractor, it is your responsibility to self-manage your taxes. This includes:

• Keeping track of your income and expenses throughout the year to ensure accurate tax filing.
• Registering for a GST/HST number if you are earning more than $30,000 CAD in one year.
• Calculating and remitting your taxes on a quarterly or annual basis depending on the type of income you are earning.
• Filing your T1 personal tax return and reporting your income on Form T2125, as well as claiming all eligible business expenses you incurred throughout the year.

Do contractors have the same rights as employees?

No, contractors do not have the same rights as employees. Generally, contractors are considered to be self-employed and are not subject to the same labour laws as employees. This means that they do not have access to the same benefits such as vacation pay or parental leave, nor are they entitled to certain workplace protections like minimum wage or overtime pay. Furthermore, employers are not responsible for withholding payroll taxes such as CPP or EI on behalf of their contractors.

Why is it important to determine whether a worker is an employee or self-employed?

It is important to determine whether a worker is an employee vs contractor because there are different legal and tax implications for each type of work arrangement. For example, employers are required to withhold payroll taxes such as CPP and EI on behalf of their employees, whereas they do not need to do so for contractors. Additionally, employees are entitled to certain workplace protections that contractors may not have access to. Therefore, it is essential that businesses take the time to accurately evaluate the working relationship in order to correctly classify individuals.

Conclusion

In conclusion, understanding the distinction between employee vs contractor is crucial for businesses operating in Canada. By correctly classifying individuals, employers can ensure compliance with tax laws, avoid legal and financial consequences, and provide fair treatment to their workers. It is essential to consider the key factors used by the CRA, such as control, financial risk, subcontracting work, intentions of the parties etc.

Seeking professional advice when needed can provide clarity and guidance. Businesses should regularly review their working relationships and contracts to ensure they accurately reflect the nature of the engagement. By prioritizing proper classification, businesses can maintain a healthy and compliant workforce. If you are looking for an accountant in Hamilton, that can provide clarity between employee vs contractor relationships for your business, contact us today.  We are here to help!

If you want to learn more about other tax and accounting topics, explore the rest of our blog!

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Disclaimer

The information provided on this page is intended to provide general information. The information does not take into account your personal situation and is not intended to be used without consultation from accounting/tax professionals. NBG Chartered Professional Accountant Professional Corporation will not be held liable for any problems that arise from the usage of the information provided on this page.

Capital gains tax is a crucial aspect of the Canadian tax system that every individual and business owner needs to understand. In Canada, the capital gains tax is levied on the realized gain or profit you make from selling your investments. The tax rate varies depending on your income level and the type of investment you hold, and it can have a significant impact on your bottom line.

In this article, we'll explore the ins and outs of capital gains tax in Canada, and share some tips and strategies for minimizing your tax liability while still making the most of your investment opportunities. Whether you're a seasoned investor or just getting started, this guide will help you navigate the complex world of capital gains tax and make the most of your investment portfolio.

What are capital gains?

A capital gain is the profit you make from selling an asset or a capital property, for more than its adjusted cost base. There are various types of capital property that generate capital gains upon their sale. The most common include:

• stocks and bonds and units of a mutual fund trust
• land
• building
• equipment you use in a business
• antiques
• cottages

Capital gains are taxed differently from other forms of income, such as wages or salaries. Instead of being taxed at your regular income tax rate, capital gains are subject to a separate tax rate known as the capital gains tax. The tax rate you pay on your capital gains depends on your income level and the type of investment you hold.

What are capital losses and their impact on capital gains tax?

Along with capital gains, investors may also experience capital losses. Capital losses occur when an asset decreases in value and is sold for less than its original purchase price. For example, if you buy a stock for $10 and sell it for $5, your capital loss would be $5. Capital losses can offset any capital gains that you make in the same year, thus reducing your total tax liability.

It's important to note that capital losses can not be used to offset other types of income you've received. Further, If your capital losses exceed capital gains, the Canada Revenue Agency (CRA) permits you to carry forward the losses to future tax years. Additionally, you may apply the losses to capital gains from the previous three tax years.

What is a realized vs. unrealized capital gain or loss?

Realized gains and losses refer to profits or losses from investments that have been sold. Unrealized gains and losses refer to profits or losses from investments that have not yet been sold.

In simple terms, a capital gain that has been realized means that it has happened for real. On the other hand, an unrealized capital gain is just an estimate of the potential gains or losses. This means that your obligation to pay capital gains tax is only triggered when a realized gain has occurred via a sale transaction. Once you sell your stocks, you no longer own them and any profit you made from the sale is your realized capital gains.

When do you pay capital gains tax in Canada?

As indicated in the section above, a capital gain is generally triggered when you sell an investment that has gone up in value. In simple cases, this is when your obligation to pay capital gains tax occurs on your tax return. However, there are other circumstances where you might be required to pay capital gains when filing your tax return. To understand when this happens, one needs to remember the term "deemed disposition".

Capital gains can be triggered in a situation called a "deemed disposition." This occurs when the nature of an asset changes in the eyes of the Canadian tax authorities due to certain life events, even if the asset remains in your possession. Examples of such events include:

• emigration
• ceasing to be a Canadian tax resident
• change of use of property from principal residence to income-earning property
• death of the taxpayer

If a deemed disposition occurs, any profits are considered as if the properties were sold at the current market value and then instantly re-bought at the same value.

It's important to keep detailed records of all capital gains and losses to ensure that you can accurately report them on your tax return. Failure to report capital gains and losses can result in penalties and interest charges.

Related: Leaving Canada: Know the Tax Implications

What is the capital gains tax rate in Canada?

In Canada, capital gains are taxed at a rate of 50% of your marginal tax rate. This means that if you sell an investment, 50% of your gain is considered taxable and will be taxed at your marginal tax rate based on your income. The only exception to this is if the CRA considers you a day trader. In such cases, all of your profits will be considered business income, and you will be taxed at your current tax rate.

Your marginal tax rate is the rate at which your last dollar of income is taxed. The total tax payable varies based on several factors, such as the amount of your income and your place of residence. This means that if you have a high income, you'll pay a higher capital gains tax rate than someone with a lower income.

How to calculate capital gains and losses?

Calculating your capital gains tax in Canada can be a complex process. To calculate your tax liability, you'll need to know the cost of your investment, the proceeds from the sale of the investment, and any expenses related to the sale. You'll also need to know your marginal tax rate and the length of time you held the investment.

To calculate capital gains or losses in Canada, you need to know the following three amounts:

1. Proceeds of disposition: this is the amount of money you received when you sold or disposed of the asset.

2. Adjusted cost base (ACB): the ACB is the original cost of the asset plus any additional costs you incurred to acquire it (like legal fees or commissions). It also includes any capital improvements you made to the asset.

3. Outlays and expenses: these include any selling costs to sell your investment such as commissions, fixing-up expenses, brokers' fees, maintenance expenses, legal fees, and finder's fees.

When you have these amounts, here’s the calculation to figure out your capital gain:

Proceeds of disposition – Adjusted Cost Base - Outlays and expenses = CAPITAL GAIN or LOSS

This will give you the capital gain or loss. If the result is positive, you have a capital gain. If it's negative, you have a capital loss.

To further calculate how much tax is payable on that capital gain, you need to follow the following steps:

1. Apply the 50% inclusion rate: In Canada, only 50% of the capital gain is subject to taxation. Multiply the capital gain by 50% to calculate the taxable capital gain.

For example, if you sold an asset with an ACB of $5,000 and Proceeds of disposition of $15,000, and zero capital outlays, your capital gain would be $10,000. The taxable capital gain based on a 50% inclusion rate is $5,000.

2. Determine your marginal tax rate: Your marginal tax rate depends on your income level. Using the same example as above, the 2023 federal and provincial brackets for someone in the highest tax bracket is 33% in federal tax and 13.16% provincially if they live in Ontario, thus making a combined marginal rate of 46.16%.

Thus, on a taxable capital gain of $5,000 with a marginal tax rate of 46.16%, the tax payable on the capital gains would be $2,308.

It's important to note that this is a simplified explanation of how to calculate capital gains and losses in Canada. The actual calculation may be more complex depending on the specific circumstances. It's always recommended to consult with a tax professional or refer to the CRA for more detailed information.

Capital gains tax exemptions and deductions

In Canada, there are several tax exemptions and deductions available that can help reduce your capital gains tax liability. The most common exemptions and deductions include the following:

1. Principal residence exemption

The principal residence exemption allows you to avoid paying capital gains tax on the sale of your primary residence. If you sell your home and it qualifies as your principal residence, you won't have to pay any tax on the capital gains you make from the sale. To qualify for the exemption, you must have lived in the property as your primary residence for the entire time you owned it.

If you've only lived in the property for part of the time you owned it, you may still be eligible for a partial exemption. The amount of the exemption will depend on the length of time you lived in the property compared to the length of time you owned it.

It's important to note that if you're selling a rental property or a vacation home, you won't be eligible for the principal residence exemption and will be subject to capital gains tax.

2. Lifetime capital gains exemption

The lifetime capital gains exemption allows you to avoid paying tax on a portion of your capital gains. The exemption applies to qualified small business corporation shares, qualified farm property, and qualified fishing property. For 2023, the lifetime capital gains exemption is $971,190. This means that you can sell qualifying assets and avoid paying tax on up to $971,190 of the capital gains you make.

To qualify for this exemption, you must have owned the shares for at least 24 months and the company must meet certain criteria.

How to avoid or minimize capital gains? tax in Canada?

Now that you understand how capital gains tax works in Canada and the impact it can have on your investment returns, let's look at some strategies you can use to minimize your tax liability.

1. Hold investments for the long term

One of the easiest ways to minimize your capital gains tax liability is to hold your investments for the long term. If you hold an investment for more than a year, you'll be subject to the capital gains tax rate of 50% of your marginal tax rate, which is generally lower than your regular income tax rate.

2. Tax-loss harvesting

Tax-loss harvesting is a strategy that involves selling investments that have decreased in value to offset gains from other investments. This can help reduce your tax liability by offsetting your capital gains with capital losses. However, it's important to be aware of the "superficial loss" rule, which prevents you from claiming a capital loss if you buy the same investment within 30 days of selling it.

Related: Year-End Tax Planning Tips - 2022

3. Utilize tax-advantaged accounts

Contributing to tax-advantaged accounts, such as Registered Retirement Savings Plans (RRSPs) and Tax-Free Savings Accounts (TFSAs), can also help minimize your capital gains tax liability. These registered accounts allow you to grow your investments tax-free or defer taxes until retirement, helping to minimize your capital gains tax liability. For example, holders of a Tax-Free Savings Account (TFSA) pay no tax of any kind whether growing or withdrawing their investment, while any investment income earned in a Registered Retirement Savings Plan (RRSP) is not taxed until it is withdrawn.  

Related: What is Non-Taxable Income in Canada?

4. Donating investments

Transferring investments, such as gifts of shares or units of a mutual fund is another way to reduce or eliminate your capital gains tax. Investments donated to a registered charity or other qualifying donee are not subject to capital gains tax or are required to be included as income on your tax return.

To be eligible to receive the tax rate of zero on any donated investments, it is essential that there is no advantage gained from donating the asset. The Canada Revenue Agency (CRA) defines an advantage as any benefit, compensation, property, service, or use that you receive as a partial expression of gratitude or consideration for the gift.

If the CRA determines that you have gained an advantage through your investment donation, only a portion of your investment will qualify for a zero capital gains tax rate. The remaining gain will be subject to a 50% tax rate, similar to a regular investment.

These are just a few strategies to consider when trying to minimize capital gains tax in Canada. It's always recommended to consult with a tax professional to fully understand the tax implications and determine the best strategy for your specific circumstances.

Common mistakes to avoid when dealing with capital gains tax

Dealing with capital gains tax can be a complicated and confusing process. Here are some common mistakes to avoid when dealing with capital gains tax:

Forgetting to include capital gains on your tax return

It's important to report all capital gains on your tax return, even if you think they may be exempt or if you only made a small profit. Failing to report your capital gains can result in penalties and interest charges.

Failing to keep accurate records

It's important to keep accurate records of all your investment transactions, including the cost of your investments, the proceeds from the sale of your investments, and any expenses related to the sale. This information will be necessary when calculating your capital gains tax liability.

Ignoring tax-advantaged accounts

Tax-advantaged accounts, such as RRSPs and TFSAs, can be a valuable tool for minimizing your capital gains tax liability. Ignoring these accounts can result in unnecessary tax payments.

Conclusion

Investing in the financial markets can be a great way to grow your wealth over time. However, it's important to understand the impact of capital gains tax on your investment returns. By understanding the basics of how capital gains are taxed, as well as the different exemptions, deductions, and strategies available, you can make informed decisions and maximize your returns. Whether you're a seasoned investor or a first-time seller, working with a tax professional can help ensure that you're maximizing your tax benefits while minimizing your tax liability. If you have any questions or concerns about capital gains tax, please contact us.  We are here to help!

If you want to learn more about other tax and accounting topics, explore the rest of our blog!

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Disclaimer

The information provided on this page is intended to provide general information. The information does not take into account your personal situation and is not intended to be used without consultation from accounting/tax professionals. NBG Chartered Professional Accountant Professional Corporation will not be held liable for any problems that arise from the usage of the information provided on this page.