ADMS 4562 Lecture Notes - Lecture 4: Property Income, Dividend Tax, Mutual Fund
11 May 2018
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3520-4: last updated on September 27, 2014 1-11
This edition of the notes was updated by Priya Shah [p_shah@yorku.ca].
1 Lecture 4: Income from Property, Capital gains and Capital Losses
1.1 Topics Covered
▪ This week’s lecture looks at the basics of how investments are taxed, i.e. the taxation of
interest, dividend and rental income (earned while the investment is held) and the taxation of
capital gains and losses (generally earned/realized when an investment is sold)
▪ CTP ch. 7 covers property income and expenses, i.e. how dividend income, interest
income, rental income and other types of property income are taxed and the expenses that
can be deducted against this income
▪ CTP ch. 8 covers capital gains and losses, i.e. how the gain on the sale of an investment
(including your home) is taxed during your lifetime
▪ As before, urls to background materials are included for those who are interested in
additional information
1.2 Designated problems
▪ Exercises 7-3, 7-6 to 7-8, self-study problem 7-4
▪ Exercises 8-2, 8-3, 8-8, 8-9 and 8-10
2 Property Income [7-2 to 7-5]
▪ passive income from investments (investment income)
▪ most interest, dividends, rental income (minus expenses) and some royalties
▪ In some cases, a corporation's activity of earning property income can be considered an active
business, e.g. a corporation earning investment income because of the number of employees
(more than 5 full-time employees throughout the year). Discussed further in ADMS 4562
▪ Most of the rules in subdivision b of Division B of Part I of the ITA apply to both income
from business and property
2.1 A few significant differences between business and property income:
▪ You cannot create or increase a property loss on a rental property with CCA
▪ For a background note on CCA, see
http://www2.parl.gc.ca/Content/LOP/ResearchPublications/prb0606-e.htm
▪ You cannot deduct cumulative eligible capital amount (CECA) and convention expenses
against property income (only business income)
▪ Attribution rules apply to property income (and capital gains, in the case of spousal loans and
transfers) but not business income
▪ You cannot deduct home office expenses against property income according to the case law
2.2 Interest Expense [7-6 to 7-10]
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3520-4: last updated on September 27, 2014 2-11
This edition of the notes was updated by Priya Shah [p_shah@yorku.ca].
▪ The general rule allowing the deduction of interest expense is ITA 20(1)(c). The conditions
are as follows:
▪ The interest expense must
▪ be pursuant to a legal obligation, e.g. a signed agreement
▪ meet a purpose test = to produce income from business or property (not capital gains)
▪ relate to funds directly used for that income-earning activity
2.2.1 Deemed Interest Expense [ITA 80.5]
▪ The deemed interest benefit on employee loans is deemed to be interest paid for purposes of
ITA 20(1)(c) and 8(1)(j)
2.2.1.1 Examples
▪ The imputed interest benefit on a loan made to an employee to buy company shares is
typically deductible (since the shares (can) earn dividend, i.e., property, income)
▪ The interest benefit is reported as employment income. The interest (deemed paid)
can be deducted as an investment expense under ITA 20(1)(c)
▪ The imputed interest benefit on a loan to buy a car for employment use is typically
partially deductible
▪ All of the interest benefit is reported 100% as employment income. The interest
(deemed paid) can be deducted partially (i.e., the % used for employment purposes)
as employment expense under s. 8(1)(j)
2.2.2 Frequently asked questions
▪ Is home mortgage interest deductible?
▪ Home mortgage interest may be deductible if the funds from the mortgage are used
directly to earn income from business or property
▪ The term “mortgage” means that real estate = collateral for the loan. Funds from most
home mortgages are used to buy a house to live in
▪ But if part of the house is rented or used for a business, then a portion of the interest
may be tax deductible
▪ Alternatively if the house is purchased with cash (or the mortgage is paid off) and the
house is re-mortgaged and the cash from the bank loan is invested directly to produce
income from a business (see Singleton case at 7-12 to 7-15) or property (mutual
funds, shares), the interest will be deductible
▪ Is interest on money borrowed to buy investments deductible?
▪ The interest may be deductible if the funds are used directly to earn income from
business or property
find more resources at oneclass.com
find more resources at oneclass.com
3520-4: last updated on September 27, 2014 3-11
This edition of the notes was updated by Priya Shah [p_shah@yorku.ca].
2.2.3 Examples of deductible interest expense, i.e., cases where the money is used to buy:
▪ Common shares
▪ because of the potential to pay unlimited dividends
▪ Real estate rental property
▪ as long as there is a reasonable expectation of profit (excluding capital gains) from the
rental property
▪ Preference shares or interest-bearing investments
▪ but the deduction is limited to income earned (grossed-up dividends or interest) because
the related income stream is fixed
▪ Gold bars/commodities/foreign exchange
▪ interest is deductible if any profits are reported as business income
▪ interest is not deductible if any “profit” is reported as a capital gain because capital gains
are not "income from business or property"
2.2.4 Examples of non-deductible interest expense; i.e., cases where the money is used to
▪ Make interest-free loans to family members
▪ because not incurred to earn income
▪ Make an RRSP contribution
▪ because ITA 18(11) denies the deduction
▪ Buy a cottage
▪ since it’s a personal use property [ITA 18(l)(h)]
▪ Interest paid on late payments under the ITA is not deductible [ITA 18(l)(t)]
2.3 Interest Income [7-39 to 7-46]
▪ Any interest earned and received during the year is taxed
▪ Interest earned during a year but not received until after the end of the year is also taxed using
an "accrual" method
▪ Example: A 2-year $100,000 term deposit issued and purchased on November 1, Year 1
does not pay interest until the end of the 2 year period (October 31, Year 3). The interest
is 5% annually (no compounding). What interest must be accrued in Yr 1? In Yr 2? In
Yr 3?
▪ by a corporation with a December 31 year end
▪ The accrual method for corporations [ITA 12(3)] = normal accounting method =
GAAP
▪ The interest that must be accrued by a corporation (assuming that none of the
years are leap years) is
▪ Yr 1: $5,000 x 61/365 = $836 for the period November 1 to December 31
▪ Yr 2: $5,000 for the period January 1 to December 31
▪ Yr 3: $5,000 x (365 - 61)/365 = $4,164 for the period January 1 to October 31
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Document Summary
Lecture 4: income from property, capital gains and capital losses. 7 covers property income and expenses, i. e. how dividend income, interest income, rental income and other types of property income are taxed and the expenses that can be deducted against this income: ctp ch. Designated problems: exercises 7-3, 7-6 to 7-8, self-study problem 7-4, exercises 8-2, 8-3, 8-8, 8-9 and 8-10. Property income [7-2 to 7-5: passive income from investments (investment income, most interest, dividends, rental income (minus expenses) and some royalties. In some cases, a corporation"s activity of earning property income can be considered an active business, e. g. a corporation earning investment income because of the number of employees (more than 5 full-time employees throughout the year). Discussed further in adms 4562: most of the rules in subdivision b of division b of part i of the ita apply to both income from business and property. 2-11: the general rule allowing the deduction of interest expense is ita 20(1)(c).
