1CHAPTER SIX - INCOME FROM PROPERTY (Div B, Subdiv b, S9-37; Subdiv f S6780.

5)
What is income from property?
Income from property is generally regarded as the return on invested capital when little or no
time, labour or attention is expended in producing the return. (ie investment income) It includes
dividends, interest, rents and royalties.
It should be noted that little is a relative term, but is used here in comparison to employment or
business activities which require significant time, labour and attention on an ongoing basis.
However, it should be noted that even such receipts could constitute business income if sufficient
time, labour and attention are expended in earning them! (Contrast an individuals bank interest
income and dividend income to the same income earned by a finance company or bank! Contrast
the rental income earned by an individual who owns a rental property to similar income earned
by a Bed & Breakfast operator or a motel chain!)
Income from property is the profit therefrom for the year, hence net of related expenses.
Income from property does not include capital gains or losses, which are considered a separate
source of income. Again, this is important in determining the appropriate rules to apply and
deductions allowed in determining income.
Interest income:
Although not defined in the ITA, the Supreme Court has defined interest as the compensation
for the use of money belonging to another. It is unclear in some situations whether an amount
paid represents interest or something else. Provisions have been legislated in the ITA and
Regulations deeming amounts to be interest and requiring them to reported in income at
specified intervals.
Accrual rules:
Annual accrual rules are required for most common sources of interest income under S12(3) for
corporations and S12(4) for individuals. When interest is actually paid, it must be included in
income to the extent it has not already been included under the accrual method per S12(1)(c).
S12(3) requires accruals on a daily basis, as we would for accounting purposes.
S12(4) only requires accruals on the anniversary date of the investment contract to the extent
the interest has not been received, and hence reported.
(See also Prescribed Debt Obligations page 353 in text.)
Deeming rules:
Interest received on sale of bonds between interest payment dates, is deemed to be interest
income and not part of proceeds in capital gain calculation.
Where an investment is made at discount and the contract makes no mention of interest but is
redeemed at par, the difference is deemed to interest income. (Eg Treasury Bills, Zero-coupon
Bonds).

Payments based on production or use of Property (Royalties):

Any amount received (cash basis) that is based on the use of or production from property is taxed
as income from property under S12(1)(g). It is usually easily distinguished from business income
based on the amount of time, labour and attention expended in earning the income (Royalties
from a book or invention are usually business income). However, there is often difficulty in
distinguishing this type of income from capital receipt, giving rise to capital gains which are
more favourably taxed.
The property involved may be real or personal.
Examples provided in the text and problems include:
a)
Clay subsoil removed from a farmers property, for which the farmer was compensated.
The land was not sold, nor was a business carried on. However, if the compensation is
related to the quantity of clay removed, S12(1)(g) would apply.
b)
Sale of all assets of a business, where part of the proceeds of sale are determined by the
magnitude of post-disposition sales. This part of the proceeds of the business sale are
therefore contingent upon production or use of the business assets. As such, this portion
of the proceeds of the business sale is taxable as income from property under S12(1)(g)
rather than as a capital gain.
Dividends from corporations resident in Canada:
Such dividends received (cash basis) are to be included in the income of the recipient taxpayer
per S12(1)(j). The amount to be included in income (taxable dividend) is 1.25 or 1.45 times the
amount received (actual dividend), where the recipient is an individual. (See below re 2
systems of gross-up and tax credit in effect as of 2006.) This is part of the system of
integration.
Integration of taxation of corporations and individual shareholders:
Corporations, like partnerships and proprietorships are simply entities employed by individuals
to carry out business and investment activities. However, corporations are the only one of these
entities which are taxed separately and file separate income tax returns. Also, dividends are a
distribution of after-tax profits from retained earnings. The concern is therefore over double
taxation; once when the income is earned by the resident corporation and again when the already
taxed income is distributed to individual shareholders as a taxable dividend.
The rationale is therefore to include in the individual shareholders income a grossed-up (or
taxable) dividend which is equal to the Pre-Tax income earned by the corporation. The
individual shareholder then calculates tax on this dividend income at their marginal income tax
rate. To alleviate the double tax, the individual is then allowed a Dividend Tax Credit, which is
deducted from taxes payable. This credit is meant to allow for the tax already paid by the
corporation when it originally earned the income now being distributed.
In this manner, CRA is able to collect tax from corporations when the income is earned, with the
final amount of tax determined in the hands of each individual shareholder when the income is
distributed as a dividend.

As of 2006, there are 2 systems of gross-up and tax credit procedures, dependant upon the
corporate tax rate applied to the income earned by the corporation. A 25% gross-up on the actual
dividend and a 20% dividend tax credit on the taxable dividend (13 1/3 % federal + 6 2/3%
assumed provincial) is applied to dividends paid out of low-rate corporate after-tax income.
(Investment income and business income eligible for the SBD, for CCPCs.) A 45% gross-up on
the actual dividend and a 31% dividend tax credit on the taxable dividend (19% federal + 12
% assumed provincial) is applied to dividends paid out of high-rate corporate after-tax income.
(Business income not eligible for the SBD for CCPCs, all income of other Private and Public
corporations.)
You should note that the dividend gross-up and tax credit procedure applies only to dividends
from taxable Canadian corporations. Dividends from non-resident corporations are taxable in
Canadian dollar equivalent values, but are not subjected to this integration procedure. Therefore
double tax does exist with respect to such dividends. (Eg US tax on US corporate income,
Canadian tax on dividend received by Canadian individual.)
Attribution Rules: S74.1-.5, S56(4.1 - 5)
Progressive tax rates provide an incentive for related persons to split income and take
advantage of lower tax rates. This might be accomplished by transferring or loaning cash or
transferring investment assets owned by the higher-rate taxpayer to related persons in lower tax
rates, without adequate compensation. The income from property or capital gains resulting from
such a transfer/loan could thus benefit from lower tax rates in the hands of these persons, yet still
be accessible to the higher-rate taxpayer.
These attribution rules cause the income earned by the (lower tax rate) recipient spouse, related
minor or related adult to be taxed in the hands of the (higher tax rate) related person who
transferred or loaned the property to split income. Attribution ceases if the transferor dies or
becomes non-resident, if the spousal relationship ends, if the minor turns 18 or if the cash or
assets transferred are returned.
Attribution of income from property rules exist for spouses, related minors and in limited
circumstances, other related adults.
Attribution of capital gains rules exist for spouses only.
Attribution of income from related adults (other than a spouse), takes place only in the case of a
low-interest loan, which resulted in income from property being taxed at lower rates in the hands
of the borrower. (Gifts, loans used for other purposes, loans resulting in income from property
taxed at the same or higher rates do not result in attribution.)
Spouses include common-law and same-sex relationships S251:
Related persons for the attribution rules include nieces and nephews. (See Exhibit 6-2 in text)
Avoiding attribution:
1.
The transfer or loan must be properly documented and fair market value consideration
must be received by the transferor.
2.
If the consideration includes a loan (debt), then interest must be charged at the prescribed
rate and always paid by January 30 of the following year.
3.
In the case of a spousal transfer, an election under S73(1) must be made to avoid the
automatic tax free rollover rules.

Under these circumstances attribution will not take place, however the transferor must report the
transfer at fair market value, potentially resulting in immediate tax consequences. (Eg capital
gains) Also, if a loan is involved, the lender must report the interest income annually. Thus the
potential benefits of income splitting are mitigated.
Exceptions to attribution:
Second (and subsequent) generation income is not considered attributable by CRA. That is,
although the income is attributed from a tax standpoint, the dollars legally belong to the
transferee. As such, reinvestment of this first generation income is no longer attributable. This
can be used to provide low-rate taxpayers with a source of non-attributable investment funds.
Provided lower rate persons have their own source of funds (full-time or part-time work, gifts
from non-related persons or non-resident relatives, inheritances) sufficient to support the
investments, attribution will not apply.
Capital gains earned by related minors are not attributable. Therefore invest in growth stocks or
equity mutual funds to generate capital gains with funds gifted from related persons. The
investments should be held In-Trust for minors to establish the investments actually belong to
the minors.
Non-deductible carrying charges on land: S18(2),(3)
Interest and property taxes on land held primarily for resale or development and vacant land held
by a business, but not used in the course of the business may only be deducted to the extent that
gross revenues from the land exceed all other expenses. Any excess interest and property taxes
are capitalized (as inventory or a capital asset, as appropriate) and are not currently deductible.
There is a limited exception for corporations whose principal business is the leasing, rental, or
sale (or development for this purpose) of real property.
Soft costs relating to period of construction of buildings:S18(3.1),(3.3)
Soft costs including interest expenses, legal and accounting fees, mortgage fees, insurance and
property taxes relating to the period of construction (renovation or alteration) of buildings must
be added to the cost of the building. They are not deductible as current expenses. Similar costs
related to the ownership of land on which the building is being constructed, must also be
capitalized. Costs such as capital cost allowance on the building, landscaping expenses and
disability related modifications to buildings are exempted from these rules. Any accounting,
legal, underwriting, etc costs pertaining to related financing are deductible according to S20(1)
(e) and are not affected by these rules.
Rental income from real property:
Rental income is calculated on an accrual basis, with prepaid expenses and unearned rental
income treated appropriately. Most common operating expenses incurred to earn the rental
income are deductible.
Capital expenditures are subject to the rules discussed in Chapter 5, with two additional CCA
restrictions related to computation of rental income from real property.

Separate classes for rental buildings acquired after 1971 and costing > $50,000:
This rule means any negative balance in the CCA class, created by the disposition of such a
rental building for proceeds exceeding UCC, cannot be offset by the cost of another rental
building. Thus, recapture would result immediately.
By the same token, terminal losses may also be triggered if proceeds are less than UCC.
Losses from rental of real property may not be created or increased with CCA:
CCA may be claimed to reduce rental income prior to CCA to zero, but may not create a loss.
Note that recapture on any dispositions is included in income prior to CCA, thus allowing CCA
on other properties to offset this recapture.
Since rental losses will reduce income from other sources such as employment, business and
capital gains, the tax department does not want such losses to be increased by CCA.
Interest Deductibility:
Generally, interest incurred (accrual basis) with a reasonable expectation of earning income
from property is deductible in accordance with S20(1)(c).
Several cases are discussed in the text (pages 336-338) with respect to what is meant by a
reasonable expectation of profit.
The determination of whether or not the interest was incurred to earn income, is based on the use
of the borrowed fundsnot the collateral security provided. Mortgage interest is not deductible
in Canada, if the mortgage proceeds were used to purchase your home. However, if the home is
provided as security to borrow funds used to purchase investments, the interest is normally
deductible. Be sure to maintain the connection between the use of funds and the interest paid.
(eg see top of page 337)
Interest is not deductible against capital gains. Therefore, if the only income which can be
derived from an investment is capital gains, then the interest would not be deductible. (eg.
investment in gold bullion, or land which is afforded capital treatment and generates no other
income)
A general planning guideline is to use savings to purchase personal use assets, and borrow to
acquire income earning assets. Since the interest is deductible, the after-tax cost of borrowing is
much reduced.
Differences between business and property income:
See page 340 in text.