In today s fast-paced world, business owners often find themselves spending a lot

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1 ISSUE THE TAX FACTOR STEERING THE OWNER-MANAGER THROUGH CAR OWNERSHIP DECISIONS In today s fast-paced world, business owners often find themselves spending a lot of time in their cars. Whether travelling to and from meetings, delivering goods, or visiting vendors or customers, a car can often seem like an extension of the office. With many owner-managers using their automobiles for business reasons, it s not surprising that as accountants we are frequently being asked to provide advice on the most tax efficient way to own a car. Often our clients want to know if it is more beneficial to buy or to lease their next car, and whether that car should be owned corporately or personally. Usually the answer to each of these questions begins with: It depends. Decisions can be impacted by many factors, including the amount of personal versus business kilometres routinely driven, how frequently an automobile is to be replaced, or an inclination towards driving a luxury class or an economy class vehicle. In this article, we examine some of the factors that might influence an ownermanager who is considering the purchase or lease of a car to be used for business purposes from the perspective of owning the car through a corporation and personally. CONTENTS Steering the owner-manager through car ownership decisions Do corporate-owned vehicles make sense? CRA s prescribed interest rates to increase The company car If a company car is made available to a business owner through a corporation, there will be tax implications both to the owner-manager and to the company. First, we will take a look at the tax implications to the corporation of either buying or leasing a vehicle. Then we will consider the tax consequences to the owner-manager of being provided with a company car in their capacity as an employee of the corporation. Tax implications to the company If the company purchases an automobile for business purposes, it will be eligible to deduct capital cost allowance (CCA), or depreciation that can be claimed for tax purposes, in respect of that vehicle when calculating its net income for income tax purposes. The amount of CCA that can be deducted is computed as a percentage of the price that was paid for the car. However, there are limits on the amount of CCA that may be claimed. The rules are complex, but basically CCA cannot be deducted on any purchase price greater than $30,000 plus applicable GST/HST and PST. The company may claim CCA at a rate of 15% on the cost of the car (subject to the limit set out above) in the year of purchase and 30% on a declining balance basis each year thereafter. In addition to CCA, a further deduction is allowed for up to $300 per month of interest paid in respect of any financing used to purchase the car.

2 2 If the company leases a vehicle for business purposes, rather than purchasing it, the company can deduct actual leasing costs, subject to a limitation of $800 per month plus GST/HST and PST. As well, the rules basically restrict the deduction of lease payments to only the portion of those payments on the first $30,000 (plus applicable GST/HST and PST) of the cost of the car. The intent in setting these limits is to essentially ensure that the level of deductions in respect of leased vehicles remains similar to that for purchased ones. Theoretically, it would appear that the corporation should be indifferent between buying or leasing a vehicle, since both would effectively yield the same bottom line result over time. However, other factors often impact the buy/lease decision, including the company s cash flow, the length of time the car will be owned or leased, and the current lease versus financing rates. Timing may also influence the decision of whether to lease or buy. Regardless of whether the company buys a car on January 1 or on December 31, the amount of CCA that may be claimed in the year of purchase will remain the same at 15% of the cost of the car, up to the limits stated above. However, if the company leases a car, a lease entered into earlier in the year would result in a larger number of lease payments being deducted from income in the first year than that of a lease entered into at the end of the year. Tax implications to the owner-manager If a company car is made available to an owner-manager, it is likely that they would be driving the car during business hours in order to fulfill their duties as an employee of the corporation. However, if the car would also be available for their personal use, the business owner would be considered to have received a taxable benefit by virtue of their employment. This benefit is called a standby charge and is taxable income to the ownermanager. The standby charge can be a significant amount depending on the cost of the car and the amount of personal kilometres driven in the year. If the company owns the car, the standby charge is based on 2% per month of the car s original cost (1.5% for automobile salespersons). If the car is leased, it is based on 2/3rds of the employer s lease cost (excluding insurance). In both cases, the standby charge is calculated on a daily basis for each day that the car is available to the ownermanager. If the owner-manager s total personal driving is less than 1,667 kilometres per 30-day period, or 20,004 kilometres if available for the full year, and represents less than 50% of the total use of the automobile, they may qualify for a reduction of the standby charge. If the reduction applies, the income inclusion for the year is the fraction of the normal standby charge that the personal distance travelled is of 20,004 kilometres (assuming the automobile was available to the employee for the entire calendar year; the latter amount will vary if the automobile is available for less than a full year). Note that there will be no taxable benefit where a car is driven only during business hours and is left at the place of business during non-business hours so that the car is not available for personal use. A taxable benefit will also arise from the personal portion of the car s operating costs. This amount is calculated by applying a flat per-kilometre rate (for 2013, $0.27 per kilometre or $0.24 per kilometre if the employee s principal source of employment is buying or leasing automobiles) to the total personal kilometres driven. Note that these rates do not apply to restrict the corporation s deduction as the full amount in respect of reasonable operating costs associated with the company car may be deducted. As an owner-manager who is able to influence the decision regarding how to own the car, the question then becomes: is there a preference from a tax perspective to either owning the car through the company or personally? Several factors will influence this part of the decision making process. One thing to consider would be the potential for a higher overall tax cost stemming from the discrepancy between what the company is able to deduct and what the owner-manager is required to include in their income. As noted above, the company s deductions are restricted to the purchase and lease limitations. However, the owner-manager will be assessed a taxable benefit (i.e. standby charge) that is calculated based on the actual value of the car or lease payments, regardless of the corporation s restrictions. The amount of personal versus business use of the car is another factor to be taken into account. This is especially true where a leased automobile is provided to an owner-manager

3 3 who uses the car more than 50% of the time for business purposes. To illustrate, consider the example of an ownermanager who travels 10,000 kilometres for personal purposes and drives 40,000 kilometres per year in total. In this case, although the standby charge reduction applies, 33% of the lease payment (2/3 x 10,000/20,004) is a taxable benefit, while only 25% (10,000/40,000) of the use of the car is personal. As a result, this particular individual may be better off leasing the car personally. The personally-owned car We ve seen that there are various factors to consider when deciding whether to lease or buy a car within a corporation. Let s now take a look at what the implications are of owning a car personally and using it for business purposes. Generally, an employee who is using their own car in order to earn employment income may be eligible to deduct for tax purposes the business-use portion of certain expenses incurred to operate their vehicle, as well as some fixed expenses. Operating expenses would include gasoline, maintenance, oil changes and repairs, car washes, insurance, and license and registration fees. Fixed costs would include CCA and interest expense for purchased vehicles and lease costs for leased vehicles. The restrictions discussed above, which limit the annual deduction of costs incurred when either purchasing or leasing a vehicle, would apply to employee-owned vehicles as well. Furthermore, when considering whether to lease or buy an automobile, an employee would likely give consideration to the same factors outlined above, including cash flow requirements and the current lease versus financing rates. In order for an employee to deduct eligible expenses, certain conditions must be met. The employee must be ordinarily required to work away from their employer s place of business, be required to pay their own automotive expenses, and must not have received a tax-free car allowance. The employee will also be required to obtain a signed form T2200 from the company, which is to be kept on file in case the Canada Revenue Agency (CRA) requests to see it. However, in a fairly recent Tax Court case (Morton Adler v. Queen), it was held that an owner-manager could not be required under his contract of employment with the corporation that he controlled to pay his own expenses. Although this was a lower level court decision, and therefore not a precedent, it does show that there may be risks for an owner-manager if they are claiming deductions from employment income in respect of a motor vehicle. For a more detailed discussion of this issue, read our Tax Bulletin titled Deducting Expenses as an Employee. In lieu of deducting automobile expenses, where an ownermanager owns their car personally, the corporation can reimburse them for business travel by paying a reasonable car allowance that would be deductible to the corporation and not taxable to the owner-manager. The CRA normally considers a reasonable allowance to be one that is based on kilometres and does not exceed (for 2013) $0.54 per kilometre for the first 5,000 kilometres of business travel and $0.48 per kilometre for each kilometre thereafter. For distances driven in the Yukon, Nunavut and the Northwest Territories, $0.04 per kilometre would be added to that rate. The company might also choose to pay an owner-manager additional salary as compensation, along with a non-taxable reimbursement, in lieu of providing a company car. In this case, any additional salary paid by the company would be deductible to the corporation and taxable to the owner-manager. In light of the above, it is possible that in some circumstances it may be more tax efficient for an owner-manager to own their own car since the added taxable income in respect of owning their car personally might be limited to additional salary as just discussed. This is in contrast to a corporate-owned car, where the inclusion of the standby charge and operating cost benefit might have a more significant impact on the owner-manager s personal taxable income. For an example illustrating these tax consequences, please see the accompanying article titled Do corporate-owned vehicles make sense? Every owner-manager will follow their own roadmap when deciding to buy or lease a car, and whether to do so personally or through a company. Consideration will need to be given to various factors and decisions will be made based on individual circumstances. Contact your BDO advisor to discuss which option is best suited to you based on your own personal situation.

4 4 DO CORPORATE-OWNED VEHICLES MAKE SENSE? There are a number of factors that need to be considered, so there is no right answer to this question. However, in the charts below, we have provided some straightforward examples. We have compared the corporate-owned alternative to owning the vehicle personally while taking additional remuneration to pay for the car at a personal level. For each alternative, the calculations consider two situations where the personal use of the vehicle is less than 50% and the standby charge reduction is available, and where personal use is greater than 50% of the total kilometres. For the purpose of this analysis, we have assumed the following: The purchase price of the car is $30,000, and the car will be traded-in at $8,750 for a similar car after four years. For simplicity, GST/HST and PST are excluded from the analysis. The operating costs of the vehicles are $0.27 per kilometre (equal to the 2013 rate per kilometre used for the operating cost taxable benefit rules). Where the vehicle is owned personally, the vehicle costs (net of residual value) that would have otherwise been incurred by the corporation will be paid to the owner-manager as a per-kilometre allowance and additional salary. The per-kilometre car allowance is calculated based on the rates the CRA would consider reasonable (for 2013): $0.54/km for the first 5,000 kilometres of business travel, and $0.48/km for business travel over 5,000 kilometres. Scenario 1: Scenario 2: 15,000 personal kilometres 40,000 kilometres in total Option 1: Corporate-Owned Vehicle Corporate Deduction: 15,000 personal kilometres 25,000 kilometres in total Capital cost allowance for 4 years $21,250 Capital cost allowance for 4 years $21,250 Operating expenses over 4 years 43,200 Operating expenses over 4 years 27,000 Total deduction to the corporation 64,450 Total deduction to the corporation 48,250 Personal Income - Car Benefit: Standby charge over 4 years 21,600 Standby charge over 4 years 28,800 Operating benefit over 4 years 16,200 Operating benefit over 4 years 16,200 Total taxable benefit over 4 years 37,800 Total taxable benefit over 4 years 45,000 Option 2: Own Car Personally, Take Additional Remuneration Corporate Deduction: Car allowance over 4 years 49,200 Car allowance over 4 years 20,400 Additional salary 15,250 Additional salary 27,850 Total deduction to the corporation 64,450 Total deduction to the corporation 48,250 Employment Income: Additional salary, allowance is non-taxable 15,250 Additional salary, allowance is non-taxable 27,850 Comparison of the Options Taxation of the Owner-Manager Additional personal taxable income where the car is owned by the corporation $22,550 Additional personal taxable income where the car is owned by the corporation $17,150

5 5 Observations: Ignoring timing differences, the owner-manager in both scenarios will receive either the use of a corporate-owned automobile, or enough remuneration before tax to pay for the car personally. The personal tax cost of the automobile benefit or the additional salary will effectively be funded by other after-tax remuneration. Under both scenarios, the corporation will spend the same net amount of money (ignoring timing differences) and the net amount expended will be deductible to the corporation. In both scenarios, the additional personal taxable income in respect of a corporate-owned car is significantly higher when compared to the receipt by the owner-manager of a business travel allowance and additional salary. In this analysis, the purchase value of the automobile is assumed to be $30,000. If the value of the vehicle had been higher than $30,000, CCA would have been restricted to $30,000 but the standby charge would have been calculated based on the full value of the vehicle. This inequity would likely be another potential strike against a corporate-owned vehicle. CRA S PRESCRIBED INTEREST RATES TO INCREASE The Canada Revenue Agency s (CRA s) prescribed interest rates will be increasing effective October 1, The prescribed rates are determined quarterly using the simple average of three-month Treasury bills (T-bills) for the first month of the preceding quarter, rounded up to the next highest whole percentage point. In July, the 90-day T-bill rate edged up over 1% and therefore, the prescribed rates for the fourth quarter of 2013 will increase by 1%. The increase will impact amounts owing to and from the CRA which are related to income tax, GST/HST and certain other duties and charges. This will be the first prescribed interest rate increase since What does this mean for income tax purposes? The interest rate that will apply on overdue taxes will increase from 5% to 6%. This rate also applies to overdue Canada Pension Plan contributions and Employment Insurance premiums. The interest rate that will apply on tax refunds owed to noncorporate taxpayers will increase from 3% to 4%. For corporate taxpayers, this rate will increase from 1% to 2%. For purposes of calculating taxable benefits for employees and shareholders on interest-free and low-interest loans, the interest rate will increase from 1% to 2%. There are other tax rules in the Income Tax Act that make reference to a prescribed interest rate, including certain rules that deal with family income splitting. In particular, the prescribed interest rate increase will impact the minimum rate to be charged on income splitting loans to certain family members. Effective October 1, 2013, the rate will increase from 1% to 2%. If you make an investment loan to a spouse, common-law partner, minor child or family trust, and charge interest on the loan at the prescribed interest rate, then any income they earn on the funds (net of the interest expense) will be taxed in their hands and not yours. The interest rate on the loan does not have to be adjusted each time the prescribed interest rate changes. Therefore, if you finalize loan arrangements by September 30, you will be able to take advantage of the 1% prescribed interest rate before the increase takes effect. For more details, refer to our recent Tax Tip: Lock in arrangements by September 30 to maximize the benefits of family income splitting loans. For further information on the impact of the prescribed interest rate increases, contact your BDO advisor. The information in this publication is current as of September 1, This publication has been carefully prepared, but it has been written in general terms and should be seen as broad guidance only. The publication cannot be relied upon to cover specific situations and you should not act, or refrain from acting, upon the information contained therein without obtaining specific professional advice. Please contact BDO Canada LLP to discuss these matters in the context of your particular circumstances. BDO Canada LLP, its partners, employees and agents do not accept or assume any liability or duty of care for any loss arising from any action taken or not taken by anyone in reliance on the information in this publication or for any decision based on it. BDO Canada LLP, a Canadian limited liability partnership, is a member of BDO International Limited, a UK company limited by guarantee, and forms part of the international BDO network of independent member firms. BDO is the brand name for the BDO network and for each of the BDO Member Firms.

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