Module 10B: Introduction to Woodlot - Income Tax and Estate Planning

Lesson Four - Miscellaneous Matters

As we mentioned before, a taxpayer who has owned a woodlot without being in business and decides to harvest the wood through a commercial operation themselves may have a deemed (assumed) sale and repurchase of the woodlot at fair market value. This “change-of-use” and the income tax rules associated with it depend on changes in the taxpayers’ intentions and/or activities with respect to the property.

The gain resulting from the deemed sale on the property changing from personal use to business use would be a capital gain. The taxpayer then has an increased cost base in the property that should be eligible for a deduction for depletion, as we discussed earlier for timber limits. However, if the timber is part of a timber limit, the stepped-up cost base is reduced for depletion purposes by the non-taxable portion of the capital gain (now 50 percent) as well as any taxable portion that has been sheltered by the capital gains deduction. Tax deductions are only allowed when expenditures are actually made, or when items included in income actually result in additional tax.

If the change in use were from personal use property to farm inventory, the rules may have different consequences. If the taxpayer is using the cash basis method of accounting, no payment has been made for the cost of the inventory and no deduction would be allowed in computing business income. The end result of such a change-of-use may be a capital gain at the time of the change with no increased deduction against business income as the timber is harvested. You should note that such a change (capital personal use property to farm inventory prior to harvesting) would be very difficult to prove.

Government Grants
The general rule is that all government grants are included in income from a business.9 If the grant relates to the cost of acquiring capital property or an outlay or expense incurred however, the taxpayer may elect to offset the grant against these amounts.

So, for a woodlot owner, a grant received could only be excluded from the calculation of the current year’s income if it was used for the actual purchase or planting of a timber limit (or perhaps the purchase of a piece of machinery) and the taxpayer elects to apply the grant against the cost of the limit (or machinery).

If the grant was received to fund general operations, such as repairs and maintenance, it would either be fully included in income - with any expenses incurred fully deducted - or it would be offset against the expenses with the net expenses being deducted. These alternative methods produce identical results.

Year End
Since 1995, unincorporated businesses (proprietorships and partnerships) have been required to have a calendar year end (December 31) for tax purposes. A corporation may choose any year end, which provides more flexibility. You may want to have a different fiscal year, for instance, if your business is seasonal, choosing a fiscal year end date to coincide with a slack time in your business.

In certain cases, corporate tax may be deferred for the first year of operations by choosing a fiscal year that will postpone the recognition of income to the second year. For example if a business is incorporated in January and income begins to be earned in October, a fiscal year of September 30 could be chosen to obtain a maximum deferral of tax to 15 months after the income is earned.

Income Splitting
In Canada, family members are mostly taxed independently on their income. This, combined with the graduated personal income tax rates, provides an opportunity and an incentive to reduce income taxes by spreading income among family members. Taxpayers and their advisors have devised various ways of splitting income and the Department of Finance has been busy blocking those methods that they find offensive.

Nevertheless, there are still many valid methods to split income and reduce the family’s total tax bill. For woodlot owners, probably the most relevant way to split income is to pay a reasonable salary or wages to spouses and children. Another is to have family members participate in the ownership of a business carried on through a corporation. Dividends can then be paid to the spouse and children over 18, resulting in lower overall taxes. (This method requires careful planning, as there are pitfalls.) 

Other methods, which are not specific to woodlot owners, include pensions splitting for seniors, making spousal RRSP contributions and spending the earnings of the higher income spouse, while the lower income spouse saves and invests. This results in investment income being taxed at a lower rate.

The benefits of income splitting are shown in this example. Let’s assume that an individual operates a woodlot and has a taxable income from it of $60,000. The individual’s spouse works part-time outside the family business and has a taxable income of $15,000. The spouse also participates in the family business by keeping books and financial records, answering phones, delivering messages, doing odd jobs, and generally helping as much as possible. The spouse has not been paid a salary or wage for these services. By paying the spouse a $15,000 salary and reducing the individual’s taxable income by the same amount, the family’s total income is unchanged. But there is a big impact on the family’s income taxes. This impact is shown below.

1. Reduction in individuals income taxes by reduction of taxable income from $60,000 to
$15,000 x 36.951  =  $5,543

2. Increase in spouse’s income taxes by increase in
taxable income from $15,000 to $30,000.
$15,000 increase at this level2  =  $4,153
Total income tax savings = $5,543 – 4,153
= $1,3903

1. See Appendix 3 for marginal income tax rates

2. Note that there are three tax brackets within this increase, for simplicity we have only shown the final tax result.

3. Note the tax rates only take into account the basic tax credit.

Claw-Back, Etc.
Several federal programs are subject to an income or means test. For instance, individuals over the age of 65 are generally entitled to Old Age Security (OAS). For 2009, this is approximately $517 per month ($6,204 per year). However, as a senior’s income rises above $66,335, the OAS is “clawed-back”.

The amount “clawed-back” is equal to 15 percent of the amount by which the individual’s net income exceeds $66,335. Thus for 2009, an individual’s OAS will be completely repayable (“clawed-back”) when their income reaches $107,695. [($107,695– 66,335) x 15% = $6,204].

The age tax credit of $5,276 available to seniors is also subject to an income test. This credit against federal taxes is reduced as income increases above $31,524. For 2009 the credit is reduced by 15 percent of the amount of net income of more than $31,524, until it is fully eroded. Once an individual’s income level is more than about $66,697 they will no longer be entitled to any age tax credit.

Other federal programs that are influenced by family income levels include the “guaranteed income supplement,” the “family benefit system,” and the “goods and services tax credit.”

Many woodlot owners (particularly those who sell stumpage) do not have a regular income from the woodlot. So, they need to consider how irregular income levels affect the benefits available under these federal programs.

You can use one of two strategies to minimize the effects of these claw-backs. The first is to spread the income over several years to avoid any unnecessary claw-backs altogether. The second is to crowd as much of the income as possible into one or two years so that the benefits will be lost for only a short period of time. When choosing a strategy, you should consider your income from other sources, the corresponding marginal tax rate, and how much income will be made from the woodlot.

Filing your taxes on time
If you operate your woodlot as a sole proprietor or a partnership, the tax return is not due to be filed until June 15th of the following year, but any taxes owing are due by April 30. If your woodlot business is incorporated, you have three months from your year end date to pay any taxes owing and six months to file the corporate tax return.

Interest is charged daily by CRA at prescribed rates for any late payments on income taxes – the rate for the first quarter of 2009 was 6 percent. Interest and penalties paid to CRA are not deductible for tax purposes. If you do not file the return on time, in addition to interest, you will be charged a penalty. The penalty is calculated as 5% of the tax balance owing, plus 1% per month up to a maximum of 12 months. However, note that if you were fined a penalty in any of the last three taxation years, the penalty for the current year would be 10% of the tax balance owing plus 2% for each full month the return is late up to a maximum of 20 months.