IFITC Chapter_4_2012

12
Accounting Income to Net Business Income for Tax Purposes
Income from a business for tax purposes is equal to: Start with: ssec. 9(1) ADD: secs. 12 to 17 ssec. 18(1), 19 sec. 67 Accounting net income (“Profit”) Income inclusions not included in “profit” Disallowed expenses and reserves Unreasonable amounts Capital losses – book losses on the disposal of capital property MINUS: ssec. 20(1) Expenses specifically allowed but not allowed in “profit”
– – – – – Deductible using GAAP; Not a capital expenditure; Incurred to earn income for tax purposes; Not a personal expense or expenditure; and Reasonable in the circumstances.
6
Other Receipts or Benefits
• Profits from an illegal business • Profits from betting, gambling, and windfalls • Subsidies • Forgiveness of debt rules
Chapter 4
Income from Business: General Concepts and Rules
1
Business Income
• Income from a business (sec. 9)
– What is profit? – The role of GAAP
2
Business Income vs. Capital Receipt
• Must be paid within two years of the end of the taxation year in which it was declared payable or accrued • If unpaid after this time, included into income • Election available to have unpaid amount deemed paid
20(1)(n), 68
20(1)(l), (m), (n)
12(1)(c), (j), (k) Interest, Dividends
82(1), 84, 89 96 to 103
Partnership income
Inducement payments, reimbursements
12(1)(x)
• Expenditure of a capital nature • Personal and living expenses
19
Other Restrictions
• Accrued Expenses
– Unpaid amounts between non-arm’s length parties
15
Deductions
• Section 18 – disallowed or restricted deductions • Act does not specify all deductible expenses • Thus, expense is usually deductible for tax purposes if:
Deferred-income plan limitations
Recreational club dues
17
18(1)(l)
Prohibited Deductions Sec. 18
ITA Reference Description Related References
18(1)(n)
18(1)(r) 18(1)(t)
Capital expenditures Exempt income Reserves and contingent liabilities Payment on discounted bonds Personal or living expenses
67, 67.1
20(1), 14(5)(b)
67.1
– Unpaid remuneration and other amounts
9
Business Income or Property Income
• Important because:
– Most property income excluded from calculation of:
• maximum RRSP contribution limit • “earned income” used for eligibility of child care expenses
Political contributions
Certain automobile expenses Payments under the Act
127(3)
ITR: 7306
18(2) to 18(8)
18(9) 18(12)
18(13)
Interest expense limitation
Prepaid expenses Work space in home limitations Superficial loss
– Observable behavioural factors or “badges of trade”
3
Exhibit 4-1
4
5
Income vs. Capital
• Damages
– Non-performance of business contract – Cancellation of agency agreements – Loss of property
– Capital gain/loss; or – Income or loss from business or from property.
8
Business Income or Property Income
• Whether the source is property or business income depends on whether taxpayer has purchased “property” or inventory • Basic test of whether income is from business or property: Is income earned active or passive?
10
Inventory Valuation
Basis of Valuation: • or lower of cost or market • Specific identification • First in, first out (FIFO) • Note: adjustment required for amortization allocation to inventory in Absorption Accounting
20(1)(c)
18
Deductibility of Expenses
• General test: To gain or produce income
– An expense or outlay must:
• Be made or incurred by the taxpayer for the purpose of gaining, producing, or maintaining income; and • Be expected to generate income related to the taxpayer’s business or property.
12(1)(b)
12(1)(d), (e) 12(1)(f) 12(1)(g) 12(1)(i) 12(1)(l)
A/R for services rendered
Reserves – Bad debts and warranties Payments based on production or use Bad debts recovered Insurance proceeds – depreciable property
20(1)(hh)
14
Inclusions
• • • • • Amounts received or receivable Inducement payments or reimbursements Restrictive covenants Partnership income Barter transactions
11
Sole Proprietorship
• Generally, must report on a calendar basis • Election available for alternative fiscal year but additional rules for reporting business income apply
7
Business Income vs. Property Income
• Property held to earn income is either: