TaxMatters@EY – June 2023

Kelsey Horning, Toronto, and Gael Melville, Vancouver

A well-established principle of tax law states that if an employer reimburses an employee’s regular commuting costs, or pays the employee an allowance to cover them, those amounts are usually taxable income for the employee because they represent personal expenses.

The law in this area hasn’t changed recently, but there have been significant changes to employees’ work practices, with many people now working from home at least part of the time. This creates novel challenges for employers in determining whether the cost of an employee’s travel to a location is a personal expense, as a recent CRA technical interpretation shows.

Tax treatment of travel allowances and reimbursements under the law

An employer will often reimburse an employee for work-related travel expenses, or pay them an allowance, for example, based on the number of kilometres travelled. These reimbursements or allowances may have to be included in the employee’s income, unless they qualify for an exception set out in the Income Tax Act (the Act).

If the employer pays a reimbursement, the value of an economic advantage the employee receives that is primarily for their benefit is included in the employee’s income.¹

However, if the employer provides an allowance, slightly different rules apply to allowances for motor vehicle expenses, like those paid to cover the cost of gas, as compared with other travel expenses, like transit tickets, unless the employee is a salesperson. The following discussion focuses on employees who are not engaged in selling property or negotiating contracts for their employer.²

For a motor vehicle travel expense allowance not to be taxable as a benefit, the main requirement is that the employee travels in the performance of the employment duties.³

On the other hand, for a non-motor vehicle travel expense allowance not to be taxable to the employee, an additional condition must be met.⁴ In this case, the employee must also travel away from the municipality and metropolitan area where the employer’s establishment is located — that is, the location to which the employee normally reports.

A reimbursement or allowance may also not have to be included in the employee’s income if it meets the conditions for the special or remote work site exceptions under the Act. For either of these exceptions to apply, the employee must be away for a period of 36 hours or longer, among other conditions.

Previous CRA positions

In factual situations concerning travel allowances, whether an allowance is taxable usually depends on whether the employee travelled in the performance of their duties. If the employee travelled to allow them to begin performing their duties, the travel will generally be deemed personal travel and the allowance will be taxable.

The CRA has issued several technical interpretations on this topic in the past, and has also provided administrative guidance in its Income Tax Folio series on the types of travel allowances that may be taxable as an employee benefit. For example, in a technical interpretation issued in 2021, the CRA indicated that an employee who alternated between close and distant workplaces received an employment benefit when they were reimbursed or paid an allowance for travelling from their home to the workplaces if both locations were regular places of employment.⁵

According to the CRA, an employee can have a regular place of employment even if they only report there for work periodically, for example, once or twice per month. If the employee only reports to a location once, or a few times, per year, it’s possible the location is not a regular place of employment.⁶ However, it’s a question of fact in every case, and in the CRA’s Income Tax Folio, there is an example given of an employee who works largely from home but attends the office every two weeks for meetings. In that case, the CRA’s view is that reimbursed travel expenses would be a taxable employment benefit.⁷

Recent CRA interpretation

In March 2023, the CRA released a technical interpretation that addressed the taxation of travel expense reimbursements and allowances provided to remote employees attending an in-person training and team-building event.⁸

In the scenario provided, an employer hired several new employees on 24-month contracts. The employees lived a significant distance from the employer’s offices and their contracts required them to work remotely, although one of the employer’s offices was also designated as each employee’s place of work.

The one exception to the employees’ remote work arrangement was a mandatory three-day training and team-building session. To cover the cost of travelling to this session, the employer provided employees with a meal allowance and reimbursed reasonable transportation and accommodation expenses, on presentation of receipts. The transportation expenses could be in the form of transportation tickets or a per-kilometre allowance for employees driving their private vehicle.

The CRA addressed the tax implications of the allowances and reimbursements from the employer, noting that amounts received for personal or living expenses are generally taxable as employment income unless an exception applies.

Reimbursements

The CRA first considered the reimbursements and whether the amounts were taxable as benefits to the employees. Reimbursement for travel of a personal nature would generally provide a measurable and quantifiable economic advantage primarily for the employee’s benefit and would therefore be taxable.

It is a question of fact whether employees received reimbursement for travel that occurred in the course of their duties or for travel of a personal nature. The CRA regards travel from an employee’s residence to their usual place of work to be travel of a personal nature. However, given the information provided, it was the CRA’s view that the employer’s office location was not the usual place of work in this situation, presumably because the employees did not regularly report to the office location. The travel would therefore be in the course of the employees’ duties and not included in the employees’ income.

Allowances

The CRA then considered the motor vehicle expense allowances and whether these could qualify for the exception for a reasonable allowance received for travelling in the performance of the employee’s duties. Since the CRA accepted that the travel as described was in the performance of duties, this exception could apply for the per-kilometre allowances.⁹

When it came to the non-motor vehicle travel expense allowances (i.e., the meal allowances), as discussed above, these would have to meet two conditions to be excluded from an employee’s income. The employee would have to incur the expenses in the performance of their duties for travelling away from the municipality and metropolitan area where the employer’s establishment to which the employee normally reports is located.

This test is different from the one described above that is applied in the context of motor vehicle expenses. Because a home office is not considered to be the employer’s establishment, this exception cannot apply, since there is no employer’s establishment where the remote employees ordinarily work. The allowance would have to be included in income unless the remote or special worksite rules apply.

Special worksite

Finally, the CRA considered the special worksite rules, which provide that a reasonable allowance for board and lodging at, and for transportation to, a special worksite is not included in income from employment, provided certain requirements are met. The requirements include that the board and lodging be at a site where the employees are performing duties of a temporary nature and that the employees be at the special worksite for at least 36 hours. The CRA noted that the situation described does involve duties of a temporary nature, so the exemption in the subsection may apply if the other criteria are met.

Conclusion

Given the rise in remote and hybrid work arrangements over the past few years, more questions are likely to arise in connection with travel reimbursements and allowances. In particular, employers may find it difficult to determine where an employee’s regular place of work is. The recent CRA technical interpretation highlights a difference in how motor vehicle and non-motor vehicle travel expense allowances are treated under the Act. Although in the particular situation outlined another exception was potentially available to prevent the allowances from being treated as taxable income, this will not always be the case.   

Kelsey Horning, Andrew Rosner and Lucie Champagne, Toronto

As announced in Ontario’s 2023-24 budget, the province is introducing the Ontario-made manufacturing investment tax credit (OMMITC) to encourage local manufacturers to invest in and expand the province’s manufacturing sector.¹ Broadly speaking, the credit is designed to encourage eligible Canadian-controlled private corporations (CCPCs) to make capital investments in buildings, machinery and equipment used in manufacturing and processing (M&P) activities in Ontario. A qualifying CCPC could receive a tax credit of up to $2 million per year.

The government estimates this new program will provide income tax support of $780 million over the next three years to qualifying CCPCs. The new credit is also intended to help create employment in Ontario’s manufacturing sector. 

The legislation to implement the credit is contained in Ontario Bill 85, Building a Strong Ontario Act (Budget Measures), 2023.²

The basics

The OMMITC is a 10% refundable corporate income tax credit for eligible expenditures of up to $20 million per taxation year made by a qualifying corporation, for a maximum credit of $2 million per year.

A corporation is a qualifying corporation for a taxation year if it:

• Is a CCPC throughout the year
• Carries on business in Ontario in the year through a permanent establishment in the province (e.g., an office, factory or workshop)
• Is not exempt from income tax

Sharing the expenditure limit

The $20 million annual limit must be shared by an associated group of corporations and will be pro-rated for short taxation years.

An associated group of qualifying corporations must agree on the allocation of the $20 million annual limit among the group, and this agreement must be filed with the Ontario minister. If the associated group fails to reach an agreement or file it with the minister, they cannot claim the credit.

Special rules apply if a qualifying corporation has more than one taxation year ending in the same calendar year, and it is associated in two or more of those taxation years with another qualifying corporation. Also, qualifying corporations will be deemed to be associated with each other if it is reasonable to believe that one of the reasons for their separate existence is to access or increase the amount of OMMITC claimed.

A qualifying corporation formed by way of an amalgamation cannot claim the credit for any expenditure incurred by a predecessor corporation if the latter was not a qualifying corporation at the time it incurred the expenditure.  

Eligible expenditures

Eligible expenditures for purposes of the OMMITC include eligible property used in M&P activities in Ontario. More specifically, these expenditures must be incurred to acquire certain capital property included in Class 1 or Class 53 for capital cost allowance (CCA) purposes.

Eligible expenditures in Class 1 include expenditures for the construction, renovation or acquisition of a building — or part of a building — that is located in Ontario and becomes available for use on or after March 23, 2023. The building must be eligible for the additional 6% CCA for eligible nonresidential buildings under federal income tax rules, in addition to the 4% CCA for other Class 1 buildings. Eligible nonresidential buildings acquired after March 18, 2007 and used 90% or more for M&P in Canada are eligible for the additional 6% allowance if a separate Class 1 election is filed, resulting in a total 10% CCA rate.³

Eligible expenditures also include machinery and equipment included in Class 53 and used in Ontario primarily to manufacture or process goods for sale or lease. The property must be acquired and available for use on or after March 23, 2023 and before 2026. After 2025, eligible machinery and equipment will include expenditures included in Class 43(a) that are used in the manufacturing or processing of goods for sale or lease. Broadly speaking, property included in Class 43(a) is eligible M&P property acquired after 2025 that would have been included in Class 53 if it had been acquired before 2026.

Eligible property also includes property — other than a building or part of a building — that is leased in the ordinary course of a business of a qualifying corporation in Ontario to a lessee who can reasonably be expected to use the property in Ontario primarily in manufacturing or processing goods for sale or lease.

Excluded property

Certain expenditures are specifically excluded for purposes of the OMMITC, including:

• Property that was owned at any time by a person or partnership with which the qualifying corporation did not deal at arm’s length at the time the property was acquired
• Property in which the qualifying corporation, or an associated corporation, held a leasehold interest at any time before acquiring the property
• Property that was acquired from a person or partnership that has a right or option to acquire or lease all or part of the property at any time
• Property for which, at the time it was acquired, the qualifying corporation granted any other person or partnership a right or option to acquire
• Property that is leased to a person that is exempt from tax under federal income tax rules⁴

Examples

The Ontario budget documents include two examples to illustrate the potential savings for 2023 where an eligible CCPC also takes advantage of temporary CCA measures that allow for the full expensing of capital property used in M&P activities.⁵

In the first example, A Co. is a small CCPC that produces sheet metal products in Ontario. All of A Co.’s income is subject to the Ontario small business corporation income tax rate. To modernize its production process, A Co. is considering purchasing new computer-controlled machinery in 2023 for a total cost of $500,000. A Co. could benefit from the following savings:

In the second example, B Co. is a large CCPC operating a plastics packaging manufacturing operation in Ontario. All of B Co.’s income is eligible for the Ontario M&P corporate income tax rate. To expand its operations to reach new markets, B Co is considering a $12 million investment in 2023 for new machinery for molding plastics. B Co. could benefit from the following savings:

Conclusion

The applicable forms to claim the OMMITC have not been released yet. The legislation also allows the government to introduce regulations that will prescribe additional types of property that would be eligible for the credit. At the time of writing, no regulations had been released.

A phase-out date for the OMMITC has not been set. However, the government will be required to conduct a review every three years to evaluate the credit for effectiveness, compliance burden and administrative costs.

The OMMITC provides a significant incentive for eligible CCPCs to invest in new buildings, machinery and equipment to increase their manufacturing activities in Ontario. Talk to your advisor for more information on how this new credit may apply to your business.   

Yiyun Chen and Winnie Szeto, Toronto

In this recent case, the Tax Court of Canada confirmed that a tenant was liable for Part XIII withholding tax on rents he paid even if he was not aware of the landlord’s nonresident status.

The taxpayer’s due diligence defence was ultimately unsuccessful, and the court ruled that the taxpayer was liable for the Part XIII tax assessed, in addition to interest and penalties.

Part XIII tax scheme

Generally, nonresident persons who earn income from property in Canada — such as rents, royalties, dividends and interest — that is not attributable to a business carried on in Canada through a permanent establishment are not subject to Part I tax under the Income Tax Act (the Act). Instead, they may be subject to Part XIII tax, which imposes a 25% withholding tax on such income, with a possible rate reduction under an applicable tax treaty between Canada and the nonresident's country of residence.¹

To ensure proper collection of Part XIII tax, the onus is placed on payers to withhold and remit the appropriate tax amount when making payments subject to Part XIII. For instance, in the case of rental payments paid or credited to a nonresident, the payer, who could be the property manager or tenant, must usually withhold Part XIII tax at 25% of the gross rent at source.²

The payer must also report the gross rent and tax withheld on Form NR4, Statement of Amounts Paid or Credited to Non-Residents of Canada. If the payer fails to withhold and remit Part XIII tax to the Canada Revenue Agency (CRA), they remain liable for the tax and may recover the amount from other payments they are required to make to the nonresident.³

Facts

In 1996, Mr. X, a shareholder of Xco, the taxpayer, leased a residential rental unit in Québec from Aco. In 2006, the unit was sold to Ms. A, one of Aco’s shareholders. In 2010, Mr. X entered into a new lease agreement for the unit with Ms. A as the lessor. From July 2011 to January 2016, Xco paid rents to Ms. A on behalf of Mr. X and no Part XIII tax was withheld from these payments.

In 2018, the CRA assessed Xco, under subsections 215(1) and (6) of the Act, for failure to withhold and remit Part XIII tax on the rental income received by Ms. A for the 2011 to 2016 taxation years, as well as interest and penalties. The CRA’s basis for this assessment was that Ms. A was a nonresident during those years.

The taxpayer disagreed and appealed the assessments to the Tax Court of Canada.

Court’s analysis and decision

In this appeal, the court had to determine whether Xco paid rent to a nonresident person such that it is liable for the failure to withhold and remit Part XIII tax on the rental income. This can be further broken down into three separate questions:

1. Was Ms. A a nonresident during the relevant taxation years?
2. Was Xco liable for Part XIII tax if Mr. X was unaware that Ms. A was a nonresident?
3. Was a due diligence defence available to Xco under the circumstances?

Determination of residency

At trial, Mr. X stated that he was never informed that Ms. A was living outside of Canada and cited evidence supporting her residency in Canada, such as a Canadian address on the deed of sale of the rental unit in 2006 and on the lease agreement in 2010, even though the agreement showed that Ms. A signed the agreement in Italy. Additionally, Ms. A had a social insurance number (SIN), a Canadian bank account and family in Canada.

However, the CRA disputed the reliability of the Canadian addresses as evidence that Ms. A lived in Canada and found no address linking Ms. A to Canada other than the rental unit. The CRA also discovered that Ms. A had a SIN, but she did not file any Canadian income tax returns or information returns.

Furthermore, the CRA reached Ms. A using an Italian phone number and Ms. A herself confirmed to the CRA that she resided in Italy. Indeed, Ms. A had sought judicial review of a decision by the CRA that denied her request for an extension of time to file under a provision of the Act that applied only to nonresidents.

The judge did not consider Ms. A’s Canadian addresses on the deed of sale or lease agreement, which were unsworn statements, to be definitive regarding her residency; the judge agreed with the CRA that the Canadian addresses were not conclusive of her residence.

After reviewing the evidence presented by both parties, the judge found that the list of factors pointing to Ms. A’s nonresidency was compelling, leading to the conclusion that she was a nonresident during the relevant years.

Knowledge requirement for Part XIII tax

The taxpayer further contended that it should only be liable for failure to withhold and remit Part XIII tax if it had knowledge that Ms. A was a nonresident; otherwise, it would be unfair and contrary to the legislative intent.

To support this argument, the taxpayer cited Curragh Inc. v The Queen, 94 DTC 1894, where the judge indicated that if a Canadian payer made payments to a Canadian agent without knowing that the beneficial owner was a nonresident, it would be difficult to see why the Canadian payer should be liable for failure to withhold and remit Part XIII tax under subsection 215(6).

However, the judge found that the decision in Curragh was inapplicable to the taxpayer’s case because the circumstances differed. In Curragh, the payment was made to a Canadian agent of the nonresident payee, and the payer in that case had knowledge that the payee was a nonresident. Additionally, the judge in Curragh did not directly address whether subsection 215(6) depended on the payer’s knowledge.

The court also reviewed the history of section 215, finding that no knowledge requirement existed when it was first introduced, and none had been added since. The court noted that if the legislators had intended to limit a resident's liability to cases where they had knowledge or belief, it would have expressly done so, as seen, for example, in subsection 116(5). Under this provision, a purchaser’s obligation to remit may be relieved if, after a “reasonable inquiry”, the purchaser had no reason to believe that the vendor was not a resident of Canada.

Due diligence defence

The taxpayer also sought to mount a due diligence defence, which is recognized by the courts with respect to some penalty provisions. However, the judge rejected this defence, citing J.K. Read Engineering Ltd. v The Queen, 2014 TCC 309, and stating that subsection 215(6) was not a penalty provision and the actual penalty provision was subsection 227(8).⁴

While a due diligence defence may have been available to Xco for subsection 227(8), the court found that the taxpayer failed to exercise a high degree of diligence by taking no steps to ensure compliance. Additionally, the taxpayer’s argument that it had no reason to believe Ms. A was a nonresident fell short of meeting the required high standard.

Ultimately, the court ruled that subsection 215(6) was devoid of any requirement that the payer must have knowledge that the payee was a nonresident. Therefore, the court agreed with the CRA that the taxpayer was liable for Part XIII tax under subsection 215(6) and was also responsible for penalties and interest under subsections 227(8) and (8.3).⁵

Lessons learned

As can be seen from the results of this case, the consequences of not complying with a Part XIII tax obligation can be harsh and there is little remedy available. Therefore, even though it might be challenging to determine a payee’s residency in some cases, a payer should always take active steps to verify. For example, payers should not rely solely on unsworn statements but must make inquiries of their own to determine a payee’s residency status. Even minor indicators suggesting nonresidency should prompt further inquiries and documentation. If it is determined that the payee is a nonresident, the payer should withhold and remit the proper amount of Part XIII tax based on the relevant income tax provisions and tax treaties. 

Last, because 3792391 Canada Inc. is an informal procedure case, the results are not binding on the CRA or any other court, even where the facts are very similar. However, informal procedure decisions can offer informative lessons and they often have influential value for other judges.  

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