AFM362 Chapter Notes - Chapter 4: Property Income, Withholding Tax, Deferred Income
SchoolUniversity of Waterloo
DepartmentAccounting & Financial Management
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Distinct Source: Each business must be recognized as a distinct source of income,
separate from employment income, income from property, and taxable capital gains.
General Rule for Determining Income or Loss: Only deductions applicable to a
specific source may be claimed against income from that source.
Business Income: A taxpayer’s income (loss) for a taxation year from a business is
their profit (loss) from that bu siness for the year.
Business Income vs Property Income: If the income is passive (requires little or no
activity by the taxpayer), it is property income. Examples include dividends, interest,
and rental income. If the income is active (requires time and e ffort), it is business
Property: Property that would produce property income includes:
- A right of any kind, a share or a ch ose (contractual right) in action
- Unless a contrary intention is evident money
- A timber resource property
- Work in progress of a business that is a profession
Distinctions Between the Treatment of Business and Property Income:
- Property income (except for rental income), is excluded from the earned income
calculation in the determination of the maximum RRSP contribution limit, wh ereas
self-employed business income is included in the earned income calculation
- The definition of “earned income” for eligibility for a deduction for child care
expenses includes business income but excludes all income from property
- Property income derived from rental properties is subject to separate rules. For
example, CCA claimed against rental income may not create or increase a loss
from rental properties.
- Business income earned by a corporation has special rules, such as the small
business deduction for active business income, and the M&P deduction for profits
derived from manufacturing. Alternatively, corporations holding properties and
investments are taxed at a much higher rate.
- The income attribution rules generally apply only to the non -arm’s length transfer
of property income and not the transfer of business income.
- Non-resident taxpayers are taxed on income from a business carried on in Canada,
while income from property is subject to withholding tax under a different part of
Determination by Corporations: Where a corporation has a business, the principal
purpose of which is to earn income from property, that income is considered passive
unless the corporation employs more than five full -time employees. Investment income
earned by a corporation is generally considered income from property. However, the Act
excludes property that is “incident to or pertains to an active business carried on by the
corporation, or that is used or held principally for the purpose of gaining or producing
income from an active business (ie interest charged on A/R).
Illegal Income: Profits from an illegal business are still taxable and substantiated,
non-capital expenditures are deductible. Certain illegal payments are not deductible.
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Profits from Gambling: Proceeds from gambling for mere pleasure have generally been
regarded as not taxable as long as the activity is not organized and not of a business
nature. The existence of organization or systems for minimizing risk indicate business
nature, in which case, the winnings would be taxable and the losses deductible.
Windfalls: In Canada, lottery winnings are not taxable.
Conversion of Accounting Income to Taxable Busines s Income: Accounting net
income is adjusted or reconciled to net business income for tax purposes by:
- The subtraction of income that is not taxable, but was included for accounting
- The addition of taxable income that was not included in accounting income
- The addition (reversal) of expenses not allowed for tax purposes (non -deductible)
that have been deducted for accounting purposes; and
- The subtraction of expenditures deductible for tax purposes, but were not
deductible for accounting purposes.
Reserves: Generally, the Act does not accept accounting reserves. Instead, reserv es
are added back to income and the Act then may offer a limited and regulated deduction
to offset this income inclusion.
Amounts Received or Receivable: Both amounts received for services yet to be
rendered (deferred revenue) and amounts receivable (accounts receivable) are generally
Profession Business WIP Election: An election is available to a taxpayer whose
business is a professional service; the election allows the exclusion of business income
in any amount in respect of work in progress at the end of the year. Where the election
is made, it must be used in all subsequent taxation years unless the election is revoked
with the permission of the CRA.
Partnerships: Partnerships are not taxable entities and do not file tax returns, but do
file an annual information return. Partners report their share of the partnership’s income
on their personal return; the income allocated from the partnership to each partner
remains the same source of income as it was at the partnership level.
Barter Transaction: When one taxpayer accepts property in exchange for goods and/or
services. Sales revenue equal to the FMV of the goods or services provided must be
recognized in income for tax purposes.
Gifts: A voluntary and gratuitous transfer of property without any expectation of reward
or payment from one person to another is a non -taxable gift.
Deductions: Expenditures are generally deductible if it is:
- 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
Contingent Liabilities: The Act disallows the deduction of expenses related to
provisions for contingent liabilities, such as environmental clean-up costs.
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