What is Income for Canadian tax purposes?
Defining what constitutes income for tax purposes is important because generally speaking, if a receipt constitutes income for tax purposes, then it will be taxable. The concept of income in Canadian law can be found in both the statute and case law. The Income Tax Act does not provide a clear definition of “income.” The Income Tax Act in subsection 2(1) states that “an income tax shall be paid… on the taxable income for each taxation year of every person resident in Canada at any time in the year.” Subsection 2(2) tells us that the “taxable income of a taxpayer for a taxation year is the taxpayer’s income for the year plus the additions and minus the deductions permitted by Division C.” These two subsections state that tax must be paid on taxable income, and that taxable income is the taxpayer’s income for the year. This definition is not very helpful because the Income Tax Act defines taxable income with the word income. Instead of providing a precise definition, the Income Tax Act explains what is included or excluded from the calculation of income. For example, section 81 of the Income Tax Act discusses what shall be excluded in the computation of income of a taxpayer and section 12 of the Income Tax Act discusses what shall be included in the computation of income.
The Supreme Court of Canada in Wood v M.N.R. stated that defining “income for income tax purposes has been left to the courts… Income is to be understood in its plain ordinary sense and given its natural meaning.” Professor Krishna described that the judicial concept of income “is a measure of gain that derives from capital, from labour, or from both combined.” Courts have developed the following characteristics of income: (1) income is distinct from capital; (2) income is usually recurring and regular; (3) the amount that the taxpayer received must belong to the taxpayer; (4) the receipt must be income in the taxpayer’s hands; (5) the gain must be convertible into money; and (6) only nominal gains are recognized.
Case Law Exclusions from Income
There are case law exclusions from income as well. Some of the recognized exclusionary categories include gambling gains, gifts, inheritances, windfalls, and damages for personal injury. This article discusses the Canadian income tax characterization of gifts.
What is a Gift?
According to Black’s Law Dictionary, a gift is a voluntary transfer of personal property without consideration. The Canada Revenue Agency states that a gift must be given freely, without a contractual or any other obligations. The Federal Court of Appeal in Bellingham v Canada stated that a gift must be a voluntary and gratuitous transfer of property. Thus, if a person transfers property to another, then it will only be a gift if the transfer is voluntary, made without an expectation of a reward, and not bound by any obligations.
There is No Gift Tax in Canada
In Bellingham, the Federal Court of Appeal said that it is well accepted that gifts and inheritances are immune from taxation since they represent non-recurring amounts and are transfers of old wealth. The Court said that income should involve the creation of new wealth. Since, gifts do not flow from a productive source of income they should be excluded from taxation. In other words, in Canada, there is no separate gift tax that applies to a gift upon transfer. On the other hand, different jurisdictions may have gift tax. For example, the U.S. has a gift tax that applies to a donor of a gift. In other words, the donor of a gift in the U.S. may be subject to a gift tax that is separate from any potential capital gains tax upon disposing a gift.
Gifts in an Employment or Business Setting
As explained above, gifts and inheritances are recognized categories that are excluded from taxation. The transferor and the transferee of a gift are not subject to any tax for having made the gift. The rationale for the exemption is that gifts and inheritances do not fall under any of the enumerated sources of income. However, if a gift flows from a productive source of income, such as the taxpayer employment or business, then the gift may be treated as income from an office, employment or business. The general rule is that gifts (whether cash, near-cash, or non-cash) received from an employer are considered to be a taxable benefit to the employee, and thus, must be reported as part of the recipient’s income. For example, in Wisla v R, the Tax Court of Canada held that a gold ring that an employee received from the company was a taxable benefit. However, the CRA exempts certain non-cash gifts and awards in certain cases. For example, if the combined value of all the non-cash gifts and awards that an employee received does not exceed $500, it does not have to he reported for that year. On the other hand, employee receipts of cash and near-cash gifts or awards are always considered taxable benefits.
The distinction between a gift and payment for services can also be murky in business settings. In Campbell v R, the taxpayer conducted teaching sessions while being a self-employed, unordained minister. No fees were collected from providing the teaching sessions, and offerings were given to the taxpayer by courts participants and these offerings were reported by him as income. During this time, the taxpayer also received cheques from a corporation. The cheques that the taxpayer received were not reported as income, but rather were considered as gifts. However, the Tax Court of Canada said that the cheques from the corporation were not gifts because the wife of one of the shareholders of the corporation that paid the cheques regularly attended the teaching sessions. The Court held that the minister provided a service of teaching and received the cheques as a result as income from the corporation.
Gifts of Capital Property
Gifting a capital property (such as real estate, shares, bonds, patents, or trademarks) entails a slightly different type of tax consequences. While the value of the gifts is tax free in the hands of the recipient, the giver may be liable to capital gains tax as a result of the disposition. (To be clear, this is tax is not a gift tax. Rather, this is capital gains tax that arises as a result of a gift of a capital property.) When a capital property is transferred voluntarily and without consideration, subsection 69(1) of the Income Tax Act states that the giver is deemed to have disposed of the capital property for proceeds equal to the fair market value of the property at the time of transfer. This essentially requires the giver to report any capital gain (or loss) on his or her income tax returns for that tax year. It’s important to note that this disposition and the capital gains thereon applies solely to the giver. In other words, the recipient will not have to report any of the associated capital gain. Instead, the recipient’s cost value of the capital property will be the fair market value of the property at the time of the transfer.
Exemptions to the Disposition Rules
The above disposition rule also has exemptions. For example, as a result of subsection 70(6) of the Income Tax Act, the disposition rule does not apply if the gift is made the giver’s wife or common-law partner. Instead, the giver is deemed to have transferred at proceeds equal to the original cost base, and thus there is no gain. The recipient will then inherit the giver’s original tax base of the property. Another exemption to the disposition rules can be found under subsection 85 of the Income tax Act. Section 85 allows the taxpayer to transfer assets into a corporation on a tax-deferred basis. Essentially, the taxpayer and the corporation will have to agree to an amount which will be the proceeds of disposition (for the transferor) and the tax cost of the property (for the transferee). The section 85 rollover is subject various requirements and it is a process that requires deliberate planning by a tax professional. If you would like to learn more about exemptions to the disposition rules, please do not hesitate to contact our knowledgeable Toronto tax lawyers.
Gift Tax Credits
Under section 118.1 of the Income Tax Act, tax credits can be claimed if a taxpayer makes a gift to a qualified donee, such as registered charities and registered municipalities. Tax credits allow taxpayers to reduce their tax liabilities dollar for dollar for the amount of the tax credit. Generally speaking, the tax credit will be limited to the eligible amount of the gift. The eligible amount of a gift will be the amount by which the fair market value of the gifted property exceeds the amount of an advantage, if applicable. An advantage is the value of the consideration that the recipient of the gift provides to the giver.
Tax Pro Tip: Documentation is Key in Gifting
When a taxpayer receives a gift, it is crucial to document the gift in writing, typically by way of a deed of gift. The reason why it is important is because the Canada Revenue Agency can attempt to collect taxes on gifted amounts if they assert that the transferred assets are actually unreported taxable income. By having proper documentation, the taxpayer can prove to the Canada Revenue Agency that the transfer is a legitimate gift that tax exempt. One of the most basic ways to properly document a gift is by preparing a deed of gift. If you have any questions about gift tax in Canada, please do not hesitate to contact one of our experienced Toronto tax lawyers.
"This article provides information of a general nature only. It is only current at the posting date. It is not updated and it may no longer be current. It does not provide legal advice nor can it or should it be relied upon. All tax situations are specific to their facts and will differ from the situations in the articles. If you have specific legal questions you should consult a lawyer."