Two quarterly newsletters have been added—one about personal issues, and one about corporate issues. They can be accessed below.

Corporate:

Issue #19 Corporate

Personal:

Issue #19 Personal

A number of circumstances and developments have come together over the past few years to make working from a home office—once almost unheard of—a common fact of business life. First and foremost, of course, is the technology (particularly communications technology) which enables the home-based worker to have access to all of the information and services available to his or her in-office counterpart. Given the right technology, it’s nearly as easy for an employee working from home to send and receive e-mails through the employer’s communications network and access the people, information, and services needed to do his or her job in the same way as it would be if he or she was at the office.

While technology has made it possible to work from home on a regular basis, other developments have made the daily commute to the office, and the maintenance of large offices in major urban centres less and less appealing. The ever increasing price of gasoline has made the cost of that daily commute prohibitively expensive in some cases. As well, there is an increased awareness of the environmental cost of having most major highways clogged each morning and evening with hundreds of thousands of cars sitting in traffic gridlock. And finally, the cost of renting office space in most major Canadian cities means that most employers are at least willing to consider the cost savings which might be realized from work-at-home or telecommuting arrangements for their employees.

Along with the greater availability of work-at-home arrangements for employees, there has been a significant increase in the number of self-employed Canadians. And while not all of the self-employed work from home, it’s fairly common for those venturing into the world of self-employment for the first time to save costs by operating their business, at least initially, out of a home office.

One of the things which makes a telecommuting or work-at-home arrangement attractive, aside from avoiding the daily commute, is the tax deductions which can be claimed. While those benefits, especially for employees, are not necessarily as generous as is popularly believed, it is the case that working from home can make costs which would be incurred in any event deductible for tax purposes.

As is usually the case in tax matters, the rules differ for employed taxpayers and for the self-employed, as the latter enjoy a greater degree of latitude in the deductions which may be claimed. That said, both the employed and the self-employed must meet the same basic two-part test in order to be eligible to deduct home office expenses, and that test is as follows:

• the home office must be the place at which the taxpayer principally (defined by the Canada Revenue Agency as more than 50% of the time) performs the duties of employment or must be the taxpayer’s principal place of business: or

• the home office must be both used exclusively for the purpose of earning income from employment or from the business and must be used on a regular and continuing basis for meeting customers or clients of the employer or the business.

A self-employed taxpayer who meets these criteria is entitled to claim (on Form T2124(E) (Statement of Business Activities)) expenses such as property taxes, rent, or mortgage interest (but not mortgage principal amounts), insurance, utilities costs etc. However, such expenses are not deductible in their entirety: rather, the taxpayer must apportion the expenses based on the percentage of the total space which is used as a home office. For example, a self-employed taxpayer whose home office takes up 15% of available floor space and who incurs $2000 each year in qualifying expenses would be entitled to deduct $300 ($2,000 times 15%) in home office expenses for that year. There is one further caveat, in that the amount of home office expenses claimed in a year cannot be greater than the amount of income from the business. It’s not, in other words, possible to run a business which produces $5,000 in income for the year and to then claim $10,000 in home office expenses relating to that business. However, where home office expenses exceed business income in any given year, the excess expenses can be carried over and claimed in a subsequent year in which there is sufficient business income to offset those expenses.

Employed taxpayers who meet the two-part test set out above must meet a further condition before being eligible to claim home office expenses, as follows:

• the employer must provide the employee with a Form T2200, which indicates that the employee is required by his or her contract of employment to provide and pay for the expenses related to the home office;
• the employee must not have been reimbursed by the employer for such expenses; and
• the expenses must have been used directly in the employee’s work at home.

Once the T2200 has been issued, and the other conditions are met, an employee who is a tenant can claim a proportionate part of his or her rent. An employee who owns his or her own home can claim a proportionate percentage of utilities and maintenance costs. An employee is not, however, entitled to claim any portion of mortgage interest, property taxes, or home insurance costs paid, and cannot claim capital cost allowance.

As is the case with self-employed taxpayers, an employee’s deduction for home office expenses cannot be greater than the income from employment income for the year to which the expenses relate. And, once again, carryover to a subsequent taxation year is allowed.

One of the tax benefits which is commonly supposed to exist for the home office workers is the right to claim depreciation (or capital cost allowance (CCA), in tax parlance) on one’s home for tax purposes. For employees, however, such a claim is simply not allowed. And, while the self-employed may be entitled to claim CCA on a home, making such a claim can create a short-term benefit with long-term costs. Making a CCA claim on one’s home is likely to erode the principal residence exemption from capital gains tax which is claimable when a home is sold, and that exemption is almost always more valuable, in monetary and tax terms, than any CCA claim which might have been made.

Being able to claim home office expenses doesn’t result in the huge tax benefits that some popular tax myths claim. However, it can and does permit qualifying taxpayers to claim a portion of home ownership (or rental) expenses which would have been incurred in any case while also avoiding the dreaded daily commute, making it a win-win scenario.

As if dealing with bills from the recent holiday season and trying to come up with the funds for an RRSP contribution weren’t enough, February is also the month in which millions of Canadian taxpayers receive an Instalment Reminder from the Canada Revenue Agency (CRA). For many of those taxpayers, who have received many such notices in the past, the reminder and the tax instalment process are familiar, although not necessarily welcome. For those who are receiving one for the first time, however, both the reminder itself and figuring out how to deal with it can be baffling.

Most Canadians, certainly those who are employed, have income tax deducted “at source”, meaning that their employer deducts an amount for income tax from their paycheques and remits it to the CRA on their behalf. However, for those who are self-employed or, frequently, those who are retired, no such deduction is automatically made from their income, and the issuance of an Instalment Reminder by the CRA may be the result.

The receipt of such a Reminder may be particularly puzzling to the newly retired, who have been accustomed to having tax deducted at source from their paycheques throughout their entire working life. However, no matter what the source of one’s income or the reason that tax has not been deducted at source, the options available to a taxpayer who receives such a reminder are the same.

Canadian federal tax rules provide that a taxpayer may be required to pay income tax by instalments where the amount of tax owing on filing is more than $3,000 in the current year (2012) and either of the two previous years (2010 or 2011). Essentially, the requirement to pay by instalments will be triggered where the amount of tax withheld from the taxpayer’s income is at least $3,000 less than their total tax liability for the current and either of the two previous years. Such instalment payments of tax are due on March 15, June 15, September 15, and December 15 of each year.

An Instalment Reminder issued by the CRA in February 2012 will specify two amounts, one to be paid by March 15 and the other due by June 15. Those amounts represent the CRA’s best estimate, based on the taxpayer’s return filed for the 2010 taxation year, of the net tax will which be payable by the taxpayer for 2012. The taxpayer then has the following three options.

First, the taxpayer can pay the amounts specified on the Reminder, by the respective due dates of March 15 and June 15. A taxpayer who does so can be certain that he or she will not face any interest or penalty charges, even if the amount paid turns out to be less than the taxes actually payable for the 2012 tax year. (If the instalments paid turn out to be more than the taxpayer’s net tax liability for 2012, he or she will of course receive a refund on filing.)

Second, the taxpayer can make instalment payments based on the amount of tax which was owed for the 2011 tax year. Where a taxpayer’s income has not changed between 2011 and 2012 and his or her available deductions and credits remain the same, the likelihood is that total tax liability for 2012 will be slightly less than it was in 2011, owing to the indexation of tax brackets and personal tax credit amounts.

Third, the taxpayer can estimate the amount of tax which he or she will owe for 2012 and can pay instalments based on that estimate. Where a taxpayer’s income will decrease from 2011 to 2012 and there will consequently be a reduction in tax payable, this option may be worth considering.

A taxpayer who elects to follow the second or third options outlined above will not face any interest or penalty charges where there is no tax payable when the return for the 2012 tax year is filed in the spring of 2013. However, should instalments paid be late or insufficient, the CRA can impose interest charges, at rates which are higher than current commercial rates. (The rate charged for the first quarter of 2012—until March 31, 2012—is 5%.) As well, where interest charges are levied, such interest is compounded daily, meaning that on each successive day, interest is levied on the previous day’s interest. It’s also possible for the CRA to impose penalties, but this is done only where the amount of instalment interest charged for the year is more than $1,000.

Most Canadian taxpayers are understandably disinclined to pay their taxes any sooner than absolutely necessary. However, ignoring an Instalment Reminder is never in the taxpayer’s best interests. Those who don’t wish to have to involve themselves in the intricacies of tax calculations can simply pay the amounts specified in the reminder. The more technical-minded (or those who want to ensure that they are paying no more than absolutely required, and are willing to take the risk of having to pay interest on any shortfall) can avail themselves of the second or third options outlined above.

It’s that time of year again, when advertisements about the wisdom of contributing to your registered retirement savings plan (RRSP) fills the airwaves and Web sites. And, since the introduction of tax-free savings accounts (TFSAs) in 2009, February is now also the month in which Canadians wrestle with the question of whether to put any available funds into an RRSP before the contribution deadline of February 29, 2012, or whether to deposit those funds instead in a TFSA.

It’s important to be clear, at the outset, that it’s not an either/or choice. Taxpayers can (and probably should) utilize both the RRSP and TFSA options in planning their financial affairs. Realistically, however, for most taxpayers the limitation is one of resources and cash flow, and it’s often not possible to fund contributions to both an RRSP and a TFSA in the same year, let alone in the same month. That said, what are the considerations which apply in determining which savings/investment vehicle is preferable for 2012?

There are some similarities between TFSAs and RRSPs. Both allow savings to grow and compound free of current tax, and for both, contributions not made in a year can be carried forward and made in any subsequent year. As well, the types of investments which can be made with RRSP or TFSA contributions are, for all intents and purposes, the same, meaning that one’s choice of investment (i.e., guaranteed investment certificates (GICs), mutual funds, bonds, etc.) should be irrelevant to the choice of RRSP vs. TFSA. However, the differences between the two savings vehicles are at least as significant as their similarities.

Perhaps most important to taxpayers, contributions made to an RRSP are deductible from income, resulting in a lower tax bill for the year of contribution and, for many taxpayers, a tax refund. Contributions to a TFSA are, on the other hand, made with after-tax funds, meaning that tax will already have been paid on the income used to make that contribution. Many taxpayers, when presented with an option which will reduce current year taxes, find that the most attractive choice. However, over the long-term, the tax consequences of choosing an RRSP over a TFSA can erode that benefit. When funds contributed (along with investment income earned on those funds) are withdrawn from a TFSA or an RRSP, the tax consequences are very different. Funds withdrawn from an RRSP (or a registered retirement income fund (RRIF) into which the RRSP has been converted) are fully taxable, without exception, at whatever tax rate applies to the taxpayer at the time of withdrawal. TFSA funds (including accumulated investment income) are withdrawn from the plan free of tax, regardless of when the withdrawal is made or the purpose to which the funds are put. And for taxpayers who are receiving Old Age Security benefits (or any other means-tested benefits) from the federal government, it is important to note that RRSP or RRIF funds withdrawn will be included in income for the purpose of determining eligibility for such benefits, while TFSA funds will not. Finally, while RRSP contributions for 2011 must be made by February 29, 2012, there is no similar deadline for TFSA contributions—they can be made at any time during the calendar year. Finally, when funds are withdrawn from a TFSA, the plan holder can “top up” the TFSA in any subsequent year by the amount of that withdrawal. Funds withdrawn from an RRSP cannot be re-contributed, unless the withdrawal was made as part of government-sanctioned withdrawal plans, like the Home Buyers’ Plan or the Lifelong Learning Plan.

The minority of working taxpayers who are members of registered pension plans will likely find the TFSA option particularly attractive. The maximum amount which can be contributed to an RRSP for the 2011 tax year is calculated as 18% of earned income for 2010, to a maximum contribution of $22,450. However, that maximum contribution is reduced, for members of RPPs, by the amount of benefits accrued during the year under the pension plan. Where the RPP is a particularly generous one, RRSP contribution room may be minimal, and a TFSA contribution the logical alternative.

In a similar way, for taxpayers over the age of 71, the RRSP v. TFSA question is simply irrelevant. Taxpayers over that age are not eligible to make contributions to an RRSP, making TFSAs the only tax-free savings vehicle to which they can make contributions. The benefit is greatest for older taxpayers whose required RRIF withdrawals are greater than their current needs. While such RRIF withdrawals must be included in income and taxed in the year of withdrawal, transferring the funds to a TFSA will allow them to continue compounding free of tax and no additional tax will be payable when and if the funds are withdrawn. And, unlike RRIF or RRSP withdrawals, monies withdrawn from a TFSA will not affect the planholder’s eligibility for Old Age Security benefits or for the federal age credit.

For younger taxpayers, where the savings goal is short-term (e.g., a down payment on a home or paying for next year’s vacation), the TFSA is clearly the better choice. While choosing to save through an RRSP will provide a deduction on that year’s return and probably a tax refund, tax will still have to be paid when the funds are withdrawn from the RRSP a year or two later. And, more significantly from a long-term point of view, using an RRSP in this way will eventually erode one’s ability to save for retirement, as RRSP contributions which are withdrawn from the plan cannot be replaced. While the amounts involved may seem small, the loss of compounding on even a small amount over 25 or 30 years can make a significant dent in one’s ability to save for retirement.

Taxpayers who are expecting their income to rise significantly within a few years (e.g., students in post-secondary or professional education or training programs) can save some tax by contributing to a TFSA while they are in school and their income (and therefore their tax rate) is low, and then withdrawing the funds tax-free once they’re working, when their tax rate will be higher. At that time, the withdrawn funds can be used to make an RRSP contribution, which will be deducted against income which would be taxed at the much higher rate, generating a tax savings. And, if a need for the funds should arise in the meantime, a tax-free TFSA withdrawal can always be made.

Financial planners and tax advisers are accustomed to being asked by clients at this time of year whether it makes more sense to pay down the mortgage (or other debt) or to contribute to an RRSP. That question has become more complicated now that the TFSA option has been added to the mix. There is, however, a solution which allows you to do both. Assuming a marginal tax rate of 45%, an RRSP contribution of $10,000 will generate a tax refund of $4,500. Contribute that $10,000 (or as much as you can) to your RRSP and, when the resulting tax refund lands in your bank account, move it to a TFSA or use it to pay down the mortgage or other debt, or split it between the two.

The Canada Revenue Agency has dedicated sections of its Web site to addressing the need of taxpayers for information about TFSAs and RRSPs, and those sections can be found at http://www.cra-arc.gc.ca/tx/tfsa-celi/menu-eng.html and http://www.cra-arc.gc.ca/tx/ndvdls/tpcs/rrsp-reer/menu-eng.html, respectively.

It’s almost impossible not to have heard that the amount of debt carried by Canadian households is at an all-time high—reaching, on average, just over 150% of household income. Carrying so much debt can be relatively painless when interest rates are at historic lows, but it’s clear that rates cannot and will not remain at such levels indefinitely.

Whether it’s because of the warnings issued by financial professionals and government officials, or just the sight of ever-increasing balances on the monthly credit card or line of credit statements, it seems that Canadians are starting to recognize that their debt loads have to be reduced. And—right on cue—a number of debt reduction companies have begun advertising their services, promising to do just that.

Typically, debt reduction companies promise to work or negotiate with an individual’s creditors in order to have the amount of outstanding debt reduced—a service for which the debtor will of course pay a fee. The claims made by some such companies can seem like a lifeline to debt-burdened families. For those dealing with calls from irate creditors and struggling to make minimum monthly payments on outstanding debts, the prospect of having those debts reduced by up to 70% is very compelling. When a promise to restore a good credit rating by removing past credit mistakes from the debtor’s credit history is added to the sales pitch, it can seem almost too good to be true. And that, in fact, is the title of a recent consumer alert issued by the Financial Consumer Agency of Canada (FCAC): “Debt Reduction Companies: Beware of “Too Good to be True” Offers. That alert is available on the Agency’s Web site at http://www.fcac-acfc.gc.ca/eng/resources/consumerAlerts/alerts_posting-eng.asp?postingId=393.

The alert issued by the FCAC examines some of the claims made by many debt reduction companies, and compares these claims to the reality of the situation. The first unrealistic claim is often the one made about the percentage by which an individual’s debt can be reduced. The FCAC notes that no creditor is required to negotiate with or speak to a debt reduction company, even if the debtor has paid a fee to have such a company negotiate on its behalf. And, even if the creditor is willing to deal with the debt reduction company, it is in no way obliged to reduce debt by any amount. In other words, it’s perfectly possible for the debtor to pay a fee but get nothing for it.

Another claim sometimes made by debt reduction companies is that they will protect the debtor’s credit rating or even “clean up” that rating by having information on past defaults or late payments eliminated. The reality is that, unless the information contained in a person’s credit rating is demonstrably inaccurate, there is no way to have it removed from the credit report. Listings of past transactions, like late payments or defaults, do eventually disappear from a credit report, but that happens after a specific period of time has elapsed, not because the removal of such information is requested or demanded by a third party. The FCAC alert also reviews claims made that working with a debt reduction agency won’t have any negative effect on the individual’s credit rating or score. It warns that some such companies delay making payments to creditors for a few months in the hope of getting better results from negotiations to reduce the debt amount and that, where that happens, those late payments are likely to be reported to the credit reporting agencies, further damaging the individual’s credit rating. In some cases, debt reduction companies encourage debtors to stop all direct contact with creditors, or even to sign a power of attorney, giving the company authority to make agreements by which the debtor will be bound, even if he or she had no knowledge of them at the time.

Perhaps the most egregious claim made by debt reduction companies is the strong impression given that they are approved by the Canadian government or even that they are operating as part of a federal government program. Neither is true. Neither the federal nor the provincial or territorial governments operate debt reduction companies, and there are no government sponsored programs offering this type of debt reduction. While it is the case a debt reduction company will usually need to be registered and/or licensed by its provincial or territorial government in order to operate as a business, that is simply an administrative requirement which applies to all companies operating in a particular province or territory. Licensing or registration does not in any way mean that the provincial or federal government has approved of or endorsed the company or its way of doing business, and any claims to the contrary are simply false.

Sometimes, debtors avail themselves of the services of debt reduction companies because they are under the incorrect impression that there is no other choice open to them to deal with their debts. There are, in fact, several options. Where a debtor intends to and is able to discharge existing debts, he or she could obtain a debt consolidation loan from a financial institution. The rate of interest charged on such a loan will almost certainly be lower than that being levied on outstanding credit card or payday loan company debts, and the debtor will be able to make a single payment instead of juggling the demands of multiple creditors. Where it’s not possible to obtain such a loan, or the debtor doesn’t feel able to manage the debt repayment process alone, the best course of action is to obtain the services of a reputable credit counseling agency, which can set up a debt management program for the debtor. As part of that program, the agency will contact the individual’s creditors to arrange a manageable payment plan which might include a reduction in interest rates charged. Once a program is in place, the individual makes payments to the credit counseling agency which, in turn, forwards payments to the individual’s creditors as agreed. As well, credit counseling agencies work with clients to help with budgeting and financial management skills, with the goal of avoiding a recurrence of the individual’s financial problems. Reputable credit counseling agencies exist in both the private and the not-for-profit sectors, and information on the latter can be found on the Credit Counselling Canada Web site at http://www.creditcounsellingcanada.ca/Home.aspx.

In many ways, getting out of debt has a lot in common with that perennial New Year’s resolution of many Canadians—losing some weight and getting in shape. With both, it’s human nature to want to believe that there is an easy, painless way of accomplishing the goal without a need to change existing habits, and so it’s easy to fall for persuasive sales pitches that claim to have a quick fix for the problem. In both cases, however, the reality is the opposite—results can only be obtained through some effort, but where that effort is made and existing habits altered, successful long-term results are possible.

Two quarterly newsletters have been added—one about individual issues and one about corporate issues. They can be accessed below.

Corporate:

Issue #16 Corporate

Individual:

Issue #16 Personal

As gas prices across Canada look to set new records, the cost of getting to work (or getting just about anywhere) is likely a topic of conversation in nearly every home and workplace in Canada. Consumers are looking for just about any way to reduce their cost of getting around.

Does the tax system offer any relief? Yes … and no. The bad news for most employed taxpayers is that the cost of driving to work and back home, and the cost of any non-work driving is considered a personal expense, for which no deduction or credit is allowed, no matter how high the cost gets. The news for employees is not, however, all bad. Those who have a commuting alternative in the form of public transit (which includes everything from subways to suburban commuter trains to ferries) can both minimize their expenditures at the gas pump and claim the cost of travel on those transit systems on their tax returns for the year.

A tax credit for the cost of using public transit is offered by the federal government and by several of the provinces, and there is no limit on the amount which may be claimed. The federal credit is calculated as 15% of the cost of public transit, and while provincial credit amounts vary, an average would be around 7%. A taxpayer would therefore be able to claim a credit (and reduce taxes which would otherwise be payable for the year) by 22% of eligible public transit costs incurred during that year.

The public transit tax credit isn’t limited to costs incurred for transit use to and from work. Costs incurred by either spouse and by any dependent children under the age of 19 who regularly purchase a weekly or monthly transit pass—for example high school or university students who use transit to get back and forth from school—can be aggregated and claimed on the return of either parent for the year. So, a family of four which incurs $600 a month in transit costs (not difficult to do where an inter-city commuter pass can cost up to $300 a month and city transit passes, even for students, can cost up to $100) can claim $7,200 in eligible transit costs per year, for which they would be able to reduce their tax bill for the year by just under $1,600.

Where public transit isn’t a viable option and employees are required, as part of their terms of employment, to use their own vehicle for work-related travel—for example, someone who is required to visit clients at their own premises for the purpose of meetings or other work-related activities—tax relief is available for the related costs. If the employer is prepared to certify on a Form T2200 that the employee was ordinarily required to work away from his employer’s place of business or in different places, that he or she is required to pay his or her own travelling expenses, and that no tax-free allowance is provided by the employer for such expenses, the employee can deduct actual expenses incurred (including the cost of gas) for such work-related travel. It goes without saying that the employee must, in order to claim that deduction, keep a record of work-related travel done as well as records of travel-related expenses incurred.

The rules governing the taxation of employee automobile allowances and available deductions for employment-related automobile use can be complicated. But, given the recent run-up in the cost of gasoline, it’s likely worth ensuring that every possible dollar of eligible expenses incurred as a result of employment-related car use is claimed.

It’s no secret that Canadians have, over the past decade or so, taken on an unprecedented level of personal and family debt. An extraordinarily low interest rate environment, the increased availability of credit through a variety of sources and credit vehicles and a generally more “relaxed” attitude toward debt have all combined to make personal debt—sometimes substantial personal debt—more the rule than the exception.

It’s no secret that Canadians have, over the past decade or so, taken on an unprecedented level of personal and family debt. An extraordinarily low interest rate environment, the increased availability of credit through a variety of sources and credit vehicles and a generally more “relaxed” attitude toward debt have all combined to make personal debt—sometimes substantial personal debt—more the rule than the exception.

The first cautions about the level of debt of Canadian families started being heard about five and a half years ago when Statistics Canada reported (at http://www.statcan.gc.ca/daily-quotidien/050916/dq050916a-eng.htm) that, in the second quarter of 2005, the average debt of Canadian households was greater than their annual disposable income. Specifically, Canadian households owed $1.08 for every dollar of disposable income.

Since that time, and particularly in the past year, a number of financial authorities, including the Bank of Canada and the Office of the Superintendent of Bankruptcy have issued statements warning of the dangers of excessive household debt. Specifically, the concern is that Canadians have, in a low interest rate environment, taken on substantial amounts of debt which cannot be sustained over the long term. Or, as put by the Bank of Canada: “Ordinary times will eventually return and, with them, more normal interest rates and costs of borrowing. It is the responsibility of households to ensure that in the future, they can service the debts they take on today”.

In February 2011, the Vanier Institute of the Family issued its annual report on The Current State of Canadian Family Finances (available on the Institute’s Web site at http://www.vifamily.ca/node/783), and that report contained figures which indicate that the level of Canadian household debt has reached two new unwelcome benchmarks. Specifically, the Institute’s report indicated that, for 2010, the average debt of Canadian families as a percentage of disposable income, had reached 150%. In other words, the average debt load of Canadian households as a percentage of disposable income has increased by nearly 50% (from 108% to 150%) over the course of the last five years. Notably, it had taken 15 years for that percentage to increase from 93% (in 1990) to 108% (in 2005). And, according to the Vanier Institute, under current trends, that “ratio could easily reach 160% within the next two years”.

In addition to the increase in debt as a percentage of disposable income, the Institute reported that, for the first time, the average debt load of Canadian families surpassed the $100,000 figure. While that number is significant in and of itself, what will likely prove to be of greater significance over the next few years is the composition of that debt.

While debt comes in an increasingly varied number of forms, there are, essentially, only two basic types of personal debt—secured and unsecured. In the former, the lender “secures” the debt against an asset owned by the borrower, meaning that if the debt is not repaid on time, the lender has the right to seize and sell the underlying asset in order to be repaid. The kind of secured debt most familiar to Canadians is, of course, a mortgage. The mortgage lender loans money to a borrower for the purchase of a house, but retains the right to seize and sell that house if the mortgage is not repaid as required. Unsecured debt, by contrast, is money provided to a borrower on no more than the strength of the borrower’s promise to repay—and the best example of that type of debt familiar to most Canadians is a credit card.

From a borrower’s perspective, the biggest difference between the two types of debts is how “exposed” the borrower is. With secured debt, the borrower has an asset whose value nearly always exceeds the amount of the debt. And, in the event that a borrower can no longer meet his or her loan obligations, the option of selling the underlying asset and repaying the debt from the proceeds of sale is always there. However, with unsecured debt, the borrower is in a much more tenuous position. Borrowers who encounter difficulty in repaying unsecured debt have no ready underlying asset which they can sell in order to rid themselves of the debt. Absent a windfall in the form of an (unlikely) lottery win, or an inheritance, unsecured debt must be repaid from current cash flow, meaning that there must either be an increase in income, or funds must be reallocated from other household expenditures. It is just this circumstance which underlies the current concern among financial authorities. And, as the Vanier Institute figures show, there is reason for that concern.

While most reports on the debt owed by Canadian families focus on the overall total debt figure, the Vanier Institute report goes one step further and breaks down the total debt load of Canadian households into its component parts. As noted, the total average outstanding debt of Canadian households (for the third quarter of 2010) now stands at just over $100,000. According to the Vanier Institute report, about $63,000 of that debt is composed of mortgage debt, meaning that, on average, the amount of debt held by Canadian households in what the Vanier Institute describes as “consumer credit/loans” (which would presumable include credit card debt, unsecured lines of credit and personal loans generally) is just over $36,000. At the current prime rate of 3%, the monthly interest cost alone (without any repayment of principal) of servicing such a debt is $90. And of course, almost no unsecured debt is provided at an interest rate as low as prime. More typically, the interest rate charged on credit card debt can range anywhere from 12% (meaning a monthly interest cost of $360.) to above 25%. The concern expressed by the Bank of Canada and the Office of the Superintendent of Bankruptcy is for what will happen should that interest cost of household indebtedness double in amount—or more.

While no one knows how quickly rates will increase or to what extent, an increase in rates in the near term is very likely. And, while most Canadians are aware that current interest rates are low, very few are likely aware of just how seldom rates have been at such low levels. The Bank of Canada maintains a record of interest rates levied on various types of debt instruments over the past 75 years—since 1935. Those figures show that, since 1935, the prime rate has been less than the current rate of 3.0% during only one time period—from March 2009 to August 2010.

As well, it’s not likely that many Canadians under the age of 45 can actually remember what it’s like to carry a significant debt load in a high interest rate environment—and what can happen when carrying that debt load becomes unsustainable. In mid-1990, the prime rate reached 14.75%, which seems very high until it is compared to the almost unimaginable 22.75% rate in effect a decade earlier in August 1981. If similar interest rates were charged on the $36,000 of consumer debt which represents the Canadian household average, the monthly interest cost alone would reach $443 (at 14.75%) or $683 (at 22.75%)—an amount that simply couldn’t be accommodated by most family budgets, which are already being squeezed by higher food and energy costs. Significant increases in the cost of non-discretionary expenditures like food and energy, when combined with higher carrying costs on existing indebtedness could create a “perfect storm” of financial pressures sufficient to push many families into bankruptcy.

It’s a gloomy scenario, to be sure—but not an unavoidable one. For families carrying significant debt, especially unsecured debt, the best option is to pay off that debt while interest rates remain low, starting with the debt carrying the highest interest rate. However, while that may be the best option, it’s not a terribly realistic one. For many Canadian families, paying off personal debt within a short time frame is just not possible, especially in the face of inflationary pressure on other household expenditures. Where paying off personal debt off in the near term isn’t possible, the next best option is to fix the interest rate levied on that debt while rates are still relatively low. A consolidation loan (at a lower, fixed rate of interest) may be possible or, where there is significant equity in the family home, it may be possible to roll the debt into the existing mortgage at a much lower rate of interest—and to fix that rate of interest at current rates for the next few years.

While the combination of inflation and rising interest rates is an unnerving one for families carrying significant personal debt, it is possible to take steps to mitigate, to some degree, the impact of those changes. The time for doing so, however, is growing shorter.

Homeowners looking for mortgage financing or re-financing may face more stringent requirements from their lending institutions following implementation of the latest federal government changes on April 18, 2011.

In the fall of 2008, the spring of 2010, and again in January of 2011, the federal government announced changes to the rules which govern mortgage financing and refinancing in Canada. In March of this year, the changes which shortened the maximum amortization period from 35 to 30 years and limited re-financing to 85% of a home’s value (down from 90%) took effect.

Implementation of a further change was deferred until April 18, 2011. As of that date, the federal government no longer provides government-backed insurance for most home equity lines of credit (HELOCs). Typically, a HELOC is a lending arrangement under which funds are made available to a homeowner, to a maximum of 80% of the value of the home. Unlike conventional mortgages, HELOCs are non-amortizing; while monthly payments are required, those payments can usually be as little as the interest accrued during the previous month and the homeowner therefore is not required to make any payments against principal.

It is that interest-only payment feature of HELOCs which has resulted in the decision to withdraw government-backed insurance. The federal government announcement (available on the Department of Finance Web site at http://www.fin.gc.ca/n11/data/11-003_1-eng.asp) summarized the change as follows: “[I]f a loan or a segment of a multi-segment loan is in the form of a revolving line of credit that does not amortize over time, it will no longer be eligible for government-backed insurance. However, with established scheduled principal and interest payments, a loan will continue to be eligible for government-backed insurance, provided it meets the underwriting standards set by the mortgage insurer.”

In effect, the change removes the “safety net” for financial institutions which provide non-amortizing HELOC financing to homeowners, in that the financial institution will no longer be able to recover any losses incurred on such financing through government-backed insurance. Given that, the likely response by lenders will be to impose more stringent income and solvency requirements on would-be borrowers.

By now, most Canadian taxpayers (with the exception of the self-employed and their spouses, who have until June 15) will have filed their 2010 income tax returns. Once the Canada Revenue Agency (CRA) has processed those millions of returns, over the next few weeks and months taxpayers across Canada will begin to receive Notices of Assessment for 2010. In most cases, the Notice of Assessment issued will simply confirm the information which the taxpayer provided on the return, perhaps with some minor arithmetical corrections. However, not infrequently, the Notice of Assessment will indicate that the CRA has disallowed or changed the amount of certain deductions or credits, or has included in income amounts not declared by the taxpayer on his or her return. When that happens, it’s time for the taxpayer to decide whether to dispute the CRA’s assessment of their tax situation.

Sometimes, the CRA will contact the taxpayer even before the return is assessed, to request further information or documentation of deductions or credits claimed (for example, information on the custody of a child where one parent has claimed an equivalent to spouse deduction, or receipts documenting child care expenses claimed). In all cases, the best thing to do is respond to such requests promptly, and to provide the requested documents or information. The CRA can assess only on the basis of information with which it is provided, and where a request for information or supporting documents for a deduction or credit claimed is ignored by the taxpayer, the assessment will proceed on the basis that that such support does not exist. Providing the requested information or supporting documents can often resolve the question to the CRA’s satisfaction, and the assessment of the taxpayer’s return can then proceed.

In other cases, it is the taxpayer who discovers, after the return is filed, that information has been inadvertently misstated, or perhaps amounts have been omitted where an information slip was received after the return was filed. In such situations, the taxpayer is often at a loss to know how to proceed, but the process for amending a return is actually quite straightforward. The first reaction in such circumstances is sometimes simply to file another, corrected return, but that’s not the right solution. Instead, the taxpayer should wait until a Notice of Assessment is received in respect of the return already filed, and then file a Notice of Adjustment with the CRA, making the necessary corrections. A Notice of Adjustment can be filed in a number of ways. The easiest and quickest way of doing of so is through the CRA Web site’s “My Account” feature, but that option is available only to taxpayers who have registered to obtain a CRA ID and password. While doing so isn’t difficult (the steps to be taken to do so are outlined on the Web site at http://www.cra-arc.gc.ca/esrvc-srvce/tx/ndvdls/myccnt/menu-eng.html), it does take a few weeks to complete the process. Taxpayers who don’t want to deal with the CRA through the Web site, or who don’t think it’s worth registering just to deal with the Agency on a single issue can obtain a hard copy of the T1 Adjustment form from the CRA Web site at http://www.cra-arc.gc.ca/E/pbg/tf/t1-adj/t1-adj-11e.pdf, or by calling the CRA Forms request line at 1-800-959-2221. The use of the actual form isn’t mandatory—a letter to the CRA signed by the taxpayers is an acceptable alternative—but using a standardized form has two benefits. First, it makes it clear to the CRA that an adjustment is being requested, and second, filling out the form will ensure that the CRA is provided with all the information needed to process the requested adjustment. Once the form or letter is completed, it should be mailed or faxed to the Tax Centre to which the original return was sent. A taxpayer who doesn’t remember where the original return was sent can go on the CRA Web site at http://www.cra-arc.gc.ca/cntct/tso-bsf-eng.html and, by selecting his or her location from a drop-down menu of provinces and cities, can obtain the address of the Tax Centre to which the adjustment request should be sent.

Once the CRA has issued an actual Notice of Assessment, and it indicates that the Agency’s assessment differs from the information provided by the taxpayer on the return, the first thing to consider is why the CRA does not agree with the return as filed. In some cases, it’s very simple—for instance, the CRA has included in income an amount received by the taxpayer but not reported, perhaps because the related information slip was mislaid or never received. In such cases, disputing the Notice of Assessment really doesn’t make sense. Although it’s common for taxpayers to think that if they didn’t receive an information slip, they don’t have to report the income, that’s not the case. Each taxpayer is responsible for keeping track of and reporting his or her own income, regardless of any administrative or other errors which may result in the taxpayer not receiving an information slip.

If the source of the disagreement is not as straightforward, the next step is for the taxpayer to contact the CRA to indicate that they disagree with the assessment and to provide the reasons for their disagreement. Taxpayers can visit their local Tax Services Office (TSO) (a listing of such offices is available on the CRA Web site at http://www.cra-arc.gc.ca/cntct/tso-bsf-eng.html) to meet with a CRA representative. The CRA does not provide “walk-in” service at their TSOs, and so it’s necessary to call ahead to make an appointment and to bring a copy of the return filed and the Notice of Assessment to the meeting. In many cases, a face-to-face meeting with a CRA representative, with all the relevant documents in front of you, is the quickest way to resolve a dispute.

If the situation still isn’t resolved by a meeting, it’s time for the taxpayer to consider filing an Objection. Filing such an Objection formally advises the CRA that the taxpayer is disputing his or her tax liability for the taxation year in question. Not incidentally, the filing of an Objection also brings to a halt any efforts undertaken by the CRA to collect taxes which it considers owing for the taxation year under dispute (although, if the taxpayer is eventually found to owe the amount in dispute, interest will have accumulated in the interim). The Objection must be in writing and must outline the taxpayer’s reasons for objecting to the CRA’s assessment. The CRA will also need the taxpayer’s social insurance number and the taxation year for which the assessment is being disputed must be identified. The CRA provides a standardized form—the T400A Objection (available on the Agency’s Web site at http://www.cra-arc.gc.ca/E/pbg/tf/t400a/README.html)—and, while the use of the CRA’s form is not obligatory, it’s a good idea. Using the standardized form will make it clear to the CRA that a formal objection is being filed, will present the necessary information in a format with which the Agency is familiar and will also mean that no required information is inadvertently omitted. It’s also helpful to include a copy of the Notice of Assessment which is being disputed. Since the CRA does not always acknowledge receipt of an Objection, ensuring delivery by sending it by registered mail should be considered. The Objection should be sent to the Chief of Appeals at the taxpayer’s TSO or the Tax Center at which the return was originally filed.

There is a time limit by which any Objection must be filed, albeit a reasonably generous one. Individual taxpayers must file an Objection by the later of 90 days from the mailing date of the Notice of Assessment (the date found at the top of page 1) or one year from the due date of the return which is being disputed. So, for 2010 tax year returns, the one-year deadline (which is usually, but not always, the later of the two dates) would be April 30, 2012 (or June 15, 2012 for self-employed taxpayers and their spouses). As with most things related to taxes, it’s best not to put it off. At the very least, if the taxpayer is ultimately found to owe some or all of the taxes assessed by the CRA, interest will have accrued on those taxes for the entire period since the filing due date and, if the filing of the Objection is delayed, the CRA may well have already commenced its collection efforts.

Eventually (at least several weeks being the usual time frame) the CRA will respond to the Objection. In the course of making its decision, the Agency may or may not contact the taxpayer for further discussions of the issues in dispute. Should the taxpayer be contacted, he or she may be asked to provide representations outlining his or her position, in writing or at a meeting. Through such representations and meetings, it may be possible for the taxpayer and the CRA to come to an agreement on the taxpayer’s tax liability. In either case, the CRA will either confirm its original assessment or change it. If the original assessment is changed, the CRA will issue a Notice of Reassessment outlining the changes. If the taxpayer continues to disagree with the CRA’s position, the next step is an appeal to the Tax Court of Canada. While in many instances taxpayers are allowed by law to represent themselves before the Tax Court, it’s generally a good idea, once things reach his point, to consult a tax lawyer before taking that next step.

The CRA also publishes a useful pamphlet entitled Resolving Your Dispute: Objection and Appeal Rights under the Income Tax Act, and that publication can be found on the CRA Web site at http://www.cra-arc.gc.ca/E/pub/tg/p148/README.html.

A final note: many taxpayers, when they receive a Notice of Assessment and determine that the CRA agrees with their return as filed, consign the Notice to the nearest garbage can or recycling container. Neither is a good idea. A Notice of Assessment, in addition to outlining the CRA’s assessment of the taxpayer’s income and tax position for the year, contains useful and necessary information on the taxpayer’s RRSP current year and carryforward contribution amounts as well as information on the taxpayer’s allowable cumulative contribution limit for TFSAs. The Notice of Assessment should be treated as part of a taxpayer’s tax records, and filed away accordingly.

The 2011-12 federal budget brought down by Minister of Finance Jim Flaherty on March 22, 2011 includes projections that call for the elimination of the federal deficit, and a return to a surplus position, by the 2015-16 fiscal year. The deficit for the 2010-11 fiscal year which ends on March 31, 2011 is expected to be just over $40 billion, and to decline by about $10 billion per year until a surplus of just over $4 billion is realized in 2015-16.

When the Minister rose to deliver the budget, the possibility of a spring election was on the minds of many those listening, and the budget does indeed include many pre-election “goodies” for taxpayers in a variety of situations. Most of the budget provisions were directed at individual taxpayers, and most of those measures were of a relieving nature. The current non-refundable tax credit provided for the cost of enrolling children in fitness-related activities will be joined by a similar credit of up to $75 per year for the cost of “artistic, cultural, recreational or developmental” activities in which a child under 16 is enrolled. A new family caregiver tax credit of up to $300 per year will be provided, beginning in 2012, to those who provide care to spouses and minor children who have a mental or physical infirmity. Students will benefit from a broadening of the rules governing eligibility for the tuition, education, and textbook tax credits, particularly with respect to courses of study taken abroad. Changes to the rules governing registered education savings plans (RESPs) will permit amounts to be transferred between individual RESPs of siblings without incurring a tax penalty. Finally, the mineral exploration tax credit, which was to have applied only to flow-through share agreements entered into on or before March 31, 2011, has been extended to March 31, 2012.

Some of the individual tax measures put forward in the budget do, however, restrict or eliminate tax benefits currently available to individual taxpayers. Beneficiaries of individual pension plans (IPPs) will, for the 2012 and subsequent taxation years, be subject to minimum withdrawal rules similar to those which govern beneficiaries of registered retirement income funds (RRIFs). Current anti-avoidance rules in respect of registered retirement savings plans (RRSPs) will be broadened to address concerns on the part of the Department of Finance with planning schemes which allow RRSP annuitants to access their RRSP funds without including those funds in income. Finally, the ambit of the tax on split income (“kiddie tax”) which limits income splitting within a family unit, will be broadened to include capital gains realized on non-arm’s length dispositions of shares, where taxable dividends on those shares would currently be subject to the tax.

While most of the budget’s provisions were directed toward individual taxpayers, there were some measures affecting business. The measure of greatest benefit to small business is likely the proposal to provide a one-time credit of up to $1,000 to offset any increase in the amount of employment insurance (EI) premiums paid by a business in 2011 over that paid in 2010. The credit is available only to employers whose 2010 EI premiums were less than $10,000. Other measures relate to the capital cost allowance (CCA) system under which depreciation is claimed on assets for tax purposes. The current accelerated CCA for manufacturing and processing assets, which allows for a 50% deduction on a straight line basis, was scheduled to expire at the end of 2011. Instead, the enhanced deduction will be available for qualifying assets purchased before 2014. As well, the list of assets to be included in CCA Class 43.2 (clean energy generation) and therefore eligible for accelerated CCA is to be expanded to include equipment used to generate electrical energy from waste heat. Finally, the energy sector will also benefit from proposed changes to the rules governing qualifying environmental trusts and the tax treatment of intangible capital expenses in oil sands projects.