Canadian Income Taxation - Ch04

CHAPTER 4:
Income
from Employment
Electronic Presentations in Microsoft PowerPoint
Copyright 2016 McGraw-Hill Ryerson, Limited. All rights reserved. 1

Income from Employment
I. Scope and Structure of Employment Income.
II. Cash Basis.
III. Employee Benefits.
IV. Allowances.
V. Deductions from Employment Income.
VI. Employment Income and the GST/PST/HST.
VIII. Efficient management of Employee
Compensation

I. Scope and Structure of Employment
Income
Employment income:
Income for providing a service where that individual is
employed by another party.
Employed is not defined within the Act.
Normally considered employed:

when they agree to provide their services,
at the full direction and control of the employer,
in return for a specific salary or wage.
FUNDAMENTAL VARIABLES
SOURCES OF INCOME TAX LAW / GUIDANCE
Employed - Defined
May provide services to another party as an independent
contractor.
Not subject to same direction or control.
Paid in the form of a fee.
Distinction is important for the following reasons:
Deductions from employment income are restricted.
Employer must withhold and remit taxes to the CRA.
Independent contractor earns business income not employment
income
EXAMPLE A TAX MANAGER AT A CPA FIRM

Employed - Defined
When the relationship is not clear, the courts consider four
factors:
Control test
Ownership of tools test
Chance of profit or loss test
Integration test

Control Test
Who determines what is done, where, when, and how?
Employer-employee Independent
relationship contractor
Employer decides Contractor decides

Ownership of Tools Test
Employer provide Contractor provide

Tools and pays for repairs Tools and pays for repairs

Chance of Profit or Loss Test
Employer takes the Contractor takes the

Risk and Rewards Risk and Rewards

Integration Test
A worker whose work is an integral part of the business is
probably an employee.
If the worker is an accessory to the business, he/she is
probably an independent contractor.
These tests may provide conflicting indicators.

When that occurs, all four tests are considered and
weighed against each other.
No one test is more important.

Employment Income
Four Fundamental Rules
1. ITA 5(1) - All formal compensation income, with
exceptions, are taxable when received.
2. ITA 6(1)(a) - All benefits, with exceptions, are
taxable when received.
3. ITA 6(1)(b) - All allowances, with exceptions,
are taxable.
4. ITA 8(2) - All deductions are disallowed
unless they are specifically allowed in the Act.

Fundamental Rules and Basic Formula
Employment income = (A + B + C) D
Where:
A = the salary, wages, commissions, gratuities,
and other forms of remuneration received.
B = the sum of the benefits received or enjoyed.
C = the sum of the allowance received.
D = deductions that are specifically permitted as
exceptions to the general rule.

II. Cash Basis
First fundamental rule - inclusion of formal
compensation arrangements:
Salary, wages and commissions (ITA 5(1))
Gratuities (ITA 5(1))
Bonuses (ITA 5(1))
Honoraria (ITA 6(1))
Directors fees (ITA 6(1))
Included on a Cash Basis
when received, not necessarily when earned.

Salary Deferrals
Gap between the time that employment
income is earned and the time that it is
received can influence the rate of tax
payable.
Delay may be beneficial to the employee if the
tax rate in the future will be lower.
TIME VALUE OF MONEY!!!!!!!!!!!!!!

Salary Deferral and
Anti-avoidance rules
Significant abuses have led to two anti-
avoidance rules:
1. Accrued bonuses must be paid within
180 days of the fiscal year end.
2. ITA 6(11) - Main purpose is to defer the
receipt of remuneration, the employee is
deemed to have received it in the year
that it was earned.
PLANNING 101 YE BONUSES!!
III. Employee Benefits
Includes:
Employee pension plans
Insurance programs
Stock options
Automobile benefits
Some are taxable in the year received;
Others are taxable at some future time or are not
taxable at all.

Taxable Benefits
The scope of the general rule is extremely broad.
ITA 6(1)(a) - Assume that all benefits are taxable
unless specifically excluded.
Most forms of compensation are deductible for
the employer.

Taxable Benefits
Common forms of taxable benefits:
Rent-free or low-rent housing,
Gifts in cash or in kind,
Group term life insurance policies,
Holiday trips, prizes, and incentive awards in
recognition of job performance,
Interest-free or low-interest loans,
Club dues when membership in the club provides little
or no advantage to the employers business.

Non-Cash Gifts
That employers will be able to give employees:
Long-Service/Anniversary Award: a separate award
may qualify as non-taxable to the extent it doesnt
exceed $500 AND is for a minimum 5 years of service
(then one every 5 years after).
Non-Cash Gifts: non-taxable providing the total cost
of the awards/gifts does not exceed $500.
Both must be to Arms Length Employees.
Excess over $500 will be taxable.

Taxable Benefits
Amount of Benefit included is the lower of:
Cost to employer of supplying the benefit, or
FMV of the benefit.
Special Benefit calculations apply to:
Use of employer automobiles.
Loans from employers.
Relocation expenses.
Stock option benefits.

Automobiles
To the extent that an automobile is for personal
use, a taxable benefit results.
There are two components:
1. ITA 6(1)(e) - Standby charge, and
2. ITA 6(1)(k) - Operating cost benefit.

Standby Charge
Employer provided vehicle
Removes the need to acquire a car.
BENEFIT
Benefit = the time period the automobile was available to

the employee for personal use.

Standby Charge
Employer owns the automobile, standby
charge =
Original Cost Number
Of the x 2% x Of Months
Automobile Available
This means 96% of the cost of vehicle will be

included
in employees income over 4 years.
Standby Charge
Employer leased automobile, standby charge =
Monthly Number
Lease x 2/3 x Of Months
Cost Available

Reduced Standby Charge
Can be reduced to reflect a low amount of
personal use.
Reduced when the distance travelled is
primarily for employment duties.
50%
or more
Personal use must be less than 20,000
kilometres for the year.

Reduced Standby Charge
Multiplying the basic standby charge for either an
owned or a leased vehicle by the following fraction:
Personal Kilometres
1,667 Kilometres x Month of Availability

Example Reduced Standby Charge
An employee drives 30,000 km in a year, 18,000 km
(60%) is for business and 12,000 km (40%) is for
personal use. The original cost for the vehicle is
$25,000 (including taxes). The standby charge is
calculated as follows:

Operating Cost Benefit
Operating Costs = Prescribed Rate x
Personal KMS
Reg. 7305.1 - For 2015, the prescribed rate is

$0.27.
Driving between home and the employers place

of business is considered personal use.

Operating Cost Benefit
ITA 6(1)(k) - Alternative Calculation:
of the standby charge
ITA 6(1)(l) employer pays portion of operating

cost for employee owned vehicle:
Personal portion is taxable benefit.

Employee Loans
ITA 6(2) - Loan-cost or interest free loans
provided by employers are a taxable benefit
Taxable Benefit = CRA Prescribed Rate actual
interest paid.
Actual interest paid must be paid be Jan 30 of
the following year.
Reg. 4301 - Prescribed rate is set by the CRA
every quarter.

Employee Loans
Special Circumstance
Home Purchase and Home Relocation Loans
ITA 80.4(4) & (6) - Rate used to determine the
deemed interest benefit is the lesser of:
The prescribed rate in the quarter the loan was
outstanding.
The prescribed rate in effect at the time the loan was
granted.
If the prescribed rate declines, the lower rate can
be used.

Employee Loans
Interest benefit relates to work relocation:
If the employee has moved 40 or more kilometres
closer to the new work location
The employee is eligible for a home relocation
deduction up to maximum of $25,000
Deduction = lesser of:
The interest benefit included in income and
$25,000
HANDOUT (QUESTION ON PP72 / 73)

Relocation Expenses
Generally reimbursement of moving expense
are not taxable.
Reimbursement of two specific types of
relocation expenses are taxable:
1. ITA 6(1)(A) / (6)(23) - Reimbursement of costs to
finance a residence is taxable.
2. ITA 6(1)(a)/6(19)-(21) - Reimbursement of loss on
sale of home:
First $15,000 - not taxable, but
one-half of any amount above $15,000 is
taxable.

Benefits Stock Options
No cash outlay provides employer resources
Employer does not receive any type of
deduction.
Employee given opportunity to purchase
ownership in company at a set price.
Benefits arise when:
Option Fair Market

<
Price Paid Value

Benefits Stock Options
Categories of Stock Options
In-The-Money Options: Stock options of public

companies with an option price below FMV at the
date the option is granted.
Not-In-The-Money Options: Stock options of public
companies with an option price equal to or greater
than the FMV at the date the option is granted.
Stock options of a CCPC.

In-The-Money Options
A taxable benefit must be included in income at
the time the option is exercised.
Benefit = FMV at Exercise Date Option Price
Any increase (or decrease) in value subsequent

to purchase date is a capital gain or loss.

Not In-The-Money Options
1. ITA 110(1)(d) - Normal employment benefit

calculated when the shares are purchased is
reduced by one-half in determining taxable
income.

Canadian Controlled Private Corporation
(CCPC)
ITA 7(1.1) - Income inclusion deferred until
shares are sold
ITA 110(1)(d.1) - the employment benefit is
reduced by one-half in determining taxable
income IF:
Employee held the shares for two years after
acquisition, or
The options werent in the money when granted.
EXAMPLE PP 74

Non-Taxable and Tax-Deferred Benefits
The Act specifically allows benefits to be
excluded from taxable income.
Some are taxable at a later time (Deferral).
Other benefits are permanently excluded from taxable
income.

Non-Taxable and Tax-Deferred Benefits
ITA 6(1)(A) - Specific benefits are excluded on a
deferred or permanent basis:
Employer contributions to a
RPP
Private health services plan (PHSP)
Employer contribution for an employee to a pooled RPP
Deferred profit-sharing plan (DPSP)
Group sickness or accident insurance
Supplementary unemployment benefit plan, and
Counseling services.
Employer scholarships to family members taxed as
scholarship income to family member

Tax-exempt Benefits
IT-470R - Arbitrary non-taxable benefits include:
Discounts on merchandise.
Subsidized meals.
Uniforms and special clothing.
In house recreational facilities
Club dues, which it is clearly to the employers advantage
to be a member of the club.
Internet at home providing primary benefit is to the
employer
Cell phones and computers primarily for business
purpose
Tuition/Training costs reimbursed if course primarily
benefit the employer.

IV. Allowances
ITA 6(1)(b) - All allowances are taxable, subject
to specific exceptions.
Allowance refers to:
a fixed, specified amount that is paid on a regular
basis,
over and above a normal salary,
to cover certain expenses incurred.
Unique aspect: do not have to account for or
provide details of how it was spent.

Exceptions
Nine specific allowances are excepted from the
general rule and considered not taxable.
Only three of the exceptions have broad
application:
1. ITA 6(1)(b)(v) - Employees selling property or
negotiating contracts.
2. ITA 6(1)(b)(vii) - Employees other than
salespeople.
3. CRA Employer Guide Overtime meals and
allowances.

Salesperson selling property or negotiating
contracts
Travel expenses include transportation, meals,
lodging, and other incidental costs.
The allowance must be reasonable:

if unreasonably high or low in relation to the actual costs
incurred, the allowance is taxable.
Tax-free allowance are not always beneficial.

Employees Other Than Salespeople
Also entitled to receive a tax-free allowance for
travel expenses.
1. Travel allowance not relating to the use of an
automobile is considered tax-free only if:
The allowance is a reasonable amount; and,
The employee travels outside the municipality or
metropolitan area in which the employer is located.

Employees Other Than Salespeople
2. Automobile allowances are considered tax-free if:
The allowance is for the purpose of travelling in the
performance of their duties as employees; and,
The allowance is reasonable
ITA (6)91)b(vii.1) - based solely on the
number of kilometres.

Overtime Meals and Allowances
3. Reasonable overtime meals not taxable if:
Employee works two or more hours of overtime after
scheduled hours.
Must be infrequent and occasional (less than three
times a week).

V. Deductions from Employment
Income
ITA 8(2) - The fourth rule states that no
deductions are permitted unless specifically
listed.
Most Common:
1. ITA 8(1)(f) - Salespeoples Expenses
2. ITA 8(1)(h)/(h.1) - Traveling Expenses
3. ITA 8(1)(i) - Professional and Union Dues
4. ITA 8(1)(i) - Cost of Supplies
5. ITA 8(1)(m) - Contributions to RPP
6. ITA 8 (13) - Works Space in Home
7. ITA 8(1)(b) Legal expenses paid to establish right to
salary or wages
Travel Expenses
ITA 8(1)(h)/(h.1) - Travel expenses incurred in
the course of work-related duties provided that
the following circumstances exist:
Ordinarily required to carry employment duties
away from the employers place of business.
Employee is required to pay the travel costs, and
Has not received a non-taxable allowance
designed to cover such costs.

Travel Expenses
No requirement that the travel costs be incurred
away from the metropolitan area of the employer.
ITA8(4) - Exception is meals 12 hours.
Travel expenses include:
Transportation, includes all methods including
vehicle costs,
Meals limited to 50%,
Lodging, and
All other expenses created by the travel activity.

Travel Expenses
ITA 67.2/67.3 - Vehicle cost, subject to limitations,
include:
Gas and oil,
General repairs,
Insurance,
Financing costs (interest), and
Capital cost or lease costs.
Limitations to Vehicle Costs
Vehicle cost limited to $30,000.
Lease cost limited to $800 per month.
Interest Cost limited to $300 per month.

Cost of Supplies Consumed
ITA 8(1)(s) - Can be deducted if:
Employment contract requires to pay for supplies,
Only if they are fully consumed when used.
Supplies consumed would include such items as

postage, stationery, and writing materials.
Tradespersons tools deduction for cost of

eligible tools in excess of $1,146 (2015) to a
maximum of $500 in deduction.

Salespeoples Expenses
Employees who are involved with the selling of
property or the negotiation of contracts are
permitted a broad range of deductions.
Can deduct all amounts expended to each
employment income,
Limited to commission earned.
Items not limited to commission:
CCA on an automobile,
Automobile financing costs.

The following items are specifically not
deductible:
1. Payments for the use of a yacht, camp, lodge,
or golf course.
2. Membership fees or dues in a club,
main purpose to provide dining, recreational,
or sporting facilities to its members.
3. Expenditures of a capital nature that have a
long-term benefit.

Deduction only allowed if all conditions are
met:
1. Must be required to pay his own expenses.
2. Must be required to carry on his duties away from
the employers place of business.
3. Must not be in receipt of a tax-free allowance.
4. Must receive commissions as part of remuneration.

Deductible items include:
Advertising and promotion
Telephone
Parking
Automobile
Supplies
Fees paid to assistants
Work space in home
Travel expenses

Work Space in Home
ITA 8(13) - Permitted only when the work space
is either:
The principal place duties are performed, or
If first condition not met, then:
Used exclusively for earning employment income,
and
Used on a regular/continuous basis for meeting
customers or clients.

Work Space in Home
Allowable Costs
Employees non salespeople:
Appropriate portion of maintenance and utility
costs.
Salespersons:
The preceding items, plus an appropriate
percentage of property taxes and house insurance
premiums.

Registered Pension Plan Contributions
Employers often contribute amounts to a
registered pension plan on behalf of an
employee.
Most RPPs permit (or require) the employee to
contribute an annual amount to the plan.
ITA 8(1)(m) - Within specified limits, contributions
made by an employee are deductible.
For 2015 The maximum RPP dollar limit is $25,370

VI. Employment Income and the
GST/PST/HST
An employer must include the value of any
GST/PST/HST when calculating the amount
of a taxable benefit for an employee.
Any employee who has expenses that are
deductible for tax purposes can claim a GST
rebate on those expenses.

VIII. Efficient Management of Employee
Compensation
A. Basic Objectives and General Tax
Principles
B. Indirect Compensation
1. Taxable Indirect Compensation
2. Non-taxable Indirect Compensation
C. Deferred Compensation
1. Registered Plans
2. Non-Registered Plans
3. Stock-Based Plans

Principles
Objective is to provide maximum satisfaction to
the employees at the least possible cost.
In general terms:
Compensation expenses are fully deductible by
employer when incurred
Fully taxable to the employee when received.

Principles
Employer can offer non-taxable or tax-deferred
compensation.
The employer can achieve further cost savings
from economies of scale.
Different forms of compensation may have
different values to different employees.

Principles
Compensation categories:
I. Direct
Salaries, hourly wages, commissions, bonuses
Fully taxable and deductible
II. Indirect
III. Deferred

B. Indirect Compensation
Indirect forms of compensation provide
employees with specific benefits.
Usually fully deductible by the employer.
Taxation to the employee varies:
some benefits are fully taxable;
others are tax-free.

Taxable Benefits
Personal use of employers automobile
Holidays trips, other prizes and incentive awards
Tuition fees paid be an employer
Life Insurance
Free personal travel derived from frequent-flyer
programs
Interest-free of low-interest loans.

Taxable Benefits
Overall Cash Savings If:
1. Employee needs the benefit and would acquire
it from after-tax disposable income
2. Employee can acquire the benefit at a lower
cost than the employee.

Taxable Indirect Compensation
Assume all benefits are taxable unless
specifically exempt.
The question arises: What value is gained by
the employer and by the employee from such
types of compensation?
EXAMPLE AT PP93

Non-Taxable Indirect Compensation
Certain benefits to be received tax-free.
CRA considers other types of benefits also to be
non-taxable. Common benefits:
Private Health Services plans
Supplementary unemployment benefits
Certain membership fees
Counselling fees
Discount on merchandise

Not taxable to the employee, but
Fully deductible by the employer as
compensation expenses.

Can create additional cash flow in two ways:
1. Eliminating tax on benefits received by the
employee.
2. Reducing costs resulting from economies of scale
when services are purchased for a large number of
employees.

Two advantages from the employees
perspective:
1. Taxing income later may result in lower tax rates
especially if payments are delayed until
retirement.
2. If delayed payments are invested, investment
returns will be achieved on pre-tax income.

Three categories of deferred plans:
1. Registered Plans
2. Non-Registered Plans
3. Stock-Based Plans

Registered Plans
Two specific registered deferred compensation
plans that provide preferential tax treatment:
1. Registered pension plan (RPP)
2. Deferred profit sharing plan (DPSP)

Registered Plans
Deductible to employer: - After-tax cost is the
same as normal compensations, i.e. salaries.
Compensation as a registered plan makes a
vast difference to the employee:
Value of the benefit is not taxed until the funds are
removed from the plan.
Investment returns on contributions are not taxable
until they are distributed to the employee.

Registered Plans An Example
Compensation Salary $3,500 Compensation RRP $3,500
Tax Rate 45% Tax Rate 45%
After-tax Compound Int. 5.5% Before tax Compound Int. 10%
Invest every year for 30 years Invest every year for 30 years
Salary $ 3,500 RPP Contribution $ 3,500

Tax (1,575) Tax (0)
After-tax Cash $ 1,925 After-tax Cash - Invest $ 3,500
Total Wealth after 30 years Total Wealth after 30 years

After tax = $ 147,000 After tax = $ 348,000

Non-Registered Plans
Non-registered deferred compensation plans:
ITA 6(1)(d) - Employee profit sharing plans
ITA 6(1)(h) - Employee trusts
ITA 6(1)(i) - Salary deferral arrangements
ITA 6 (1)(a)(ii) - Retirement compensation
arrangements

Non-Registered Plans
Seldom used because there is no tax relief for
the amounts deferred.
Payments to the plan are deductible from the
employers income but
Are taxable, along with any investment returns,
in the employees income in the year in which
they are received by the plan.

Stock-Based Plans
Stock Options
Employee: taxation from stock option benefits
was described earlier.
Taxation depends on type of corporation
Employer: this form of incentive is attractive
because it does not involve a cash payment
Does result in dilution of ownership.

Stock-Based Plans
Stock Purchase Plans
Permits employees to purchase shares from the
corporate treasury at FMV using funds loaned by
the employer.
Funds loaned to the employees come back to the
company in exchange for the shares,
No cash cost to the employer.

Stock-Based Plans
Stock Bonus Plans
Employer issues shares in lieu of a cash
bonus.
Full value of shares received as a stock bonus
is taxable:
As employment income in the year shares
are issued.
No cash cost to the employer
Result is a tax cost to the employee.

Stock-Based Plans
Phantom Stock Plan
Does not actually provide shares;
it is an elaborate deferred bonus agreement.
Bonus tied directly to changes in the value of the
corporations shares.
Benefit to Employer: it preserves cash flow until
the end of the vesting period.
Benefit to Employee: The company shares its
profits with them on a tax-deferred basis.

Canadian Income Taxation - Ch04

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CHAPTER 4:

Electronic Presentations in Microsoft PowerPoint

Copyright 2016 McGraw-Hill Ryerson, Limited. All rights reserved. 1

Copyright 2016 McGraw-Hill Ryerson, Limited. All rights reserved. 2

Employed is not defined within the Act.

Normally considered employed:

EXAMPLE A TAX MANAGER AT A CPA FIRM

Copyright 2016 McGraw-Hill Ryerson, Limited. All rights reserved. 4

Copyright 2016 McGraw-Hill Ryerson, Limited. All rights reserved. 5

Employer decides Contractor decides

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Employer provide Contractor provide

Copyright 2016 McGraw-Hill Ryerson, Limited. All rights reserved. 7

Employer takes the Contractor takes the

Copyright 2016 McGraw-Hill Ryerson, Limited. All rights reserved. 8

These tests may provide conflicting indicators.

Copyright 2016 McGraw-Hill Ryerson, Limited. All rights reserved. 9

Copyright 2016 McGraw-Hill Ryerson, Limited. All rights reserved. 10

Copyright 2016 McGraw-Hill Ryerson, Limited. All rights reserved. 11

Copyright 2016 McGraw-Hill Ryerson, Limited. All rights reserved. 12

TIME VALUE OF MONEY!!!!!!!!!!!!!!

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Copyright 2016 McGraw-Hill Ryerson, Limited. All rights reserved. 15

Copyright 2016 McGraw-Hill Ryerson, Limited. All rights reserved. 16

Copyright 2016 McGraw-Hill Ryerson, Limited. All rights reserved. 17

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Benefit = the time period the automobile was available to

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This means 96% of the cost of vehicle will be

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Copyright 2016 McGraw-Hill Ryerson, Limited. All rights reserved. 25

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Reg. 7305.1 - For 2015, the prescribed rate is

Driving between home and the employers place

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ITA 6(1)(l) employer pays portion of operating

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Copyright 2016 McGraw-Hill Ryerson, Limited. All rights reserved. 30

HANDOUT (QUESTION ON PP72 / 73)

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Option Fair Market

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In-The-Money Options: Stock options of public

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Benefit = FMV at Exercise Date Option Price

Any increase (or decrease) in value subsequent

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1. ITA 110(1)(d) - Normal employment benefit

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The allowance must be reasonable:

Tax-free allowance are not always beneficial.

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