Taxes and Your Investments

The only real number that matters in investing is what you make after the Canada Revenue Agency takes its share. This is known as your after-tax rate of return.

A fixed-income investment paying 7% sounds good but consider your after-tax return. If you were in the top income-tax bracket of around 50 percent, you would take home only about 3.5%, which is quite a difference (assuming the investment is outside of your RRSP).

What is more, the amount of tax you pay varies with the type of investment and how you arrange your portfolio. These factors can have a great impact on your after-tax return. (Note that you don’t have to pay any tax on gains earned by money in a tax-sheltered account such as an RRSP or a RRIF until you make a withdrawal.)

The most heavily taxed types of investments are those such as GICs and CSBs that earn you interest income. Stocks, real estate and other investments that entail more risk but have the potential for higher returns in the form of capital gains are taxed less.

Dividends from Canadian corporations have the lowest effective tax rate.

Tax Loopholes

Here’s a little-known tax fact: most tax loopholes are intentional, created by the Ministry of Finance to stimulate certain sectors of the economy. For example, if your employer buys a $30,000 car on Dec. 31, you can write off half a year’s depreciation, or $4,500, even though this new asset was held for only one day.

This is no oversight. More likely, it’s an incentive for businesses to purchase cars. In contrast, true tax loopholes are unintentional benefits you find only by reading between the lines of the Income Tax Act.

For example, consider the tax-saving opportunity that presents itself if your spouse has losses on investments and you have gains:
Shifting Capital Loss From One Spouse to Another

Imagine Susan is sitting on a capital loss this year, while her husband, Tim, realized a capital gain. According to the letter of the law, Tim cannot use Susan’s loss to offset his gain. He will have to pay tax on his gain, while Susan’s loss remains unused until she can apply it to a future capital gain of her own.

By reading the Income Tax Act closely, there is a solution. To share a capital loss with her husband, all Susan has to do is sell her losing shares to Tim, allowing him to claim the loss as his own. Let’s explain. We’ll assume that Susan’s shares originally cost $10,000, but are now worth $1,000 – a potential loss of $9,000. She sells the shares to Tim at the fair market value of $1,000, then elects on her income tax return not to have the transaction occur at cost.

This allows her husband, as the purchaser of the shares, to add the $9,000 capital loss to his adjusted cost base for tax calculation purposes. Now Tim owns shares with a fair market value of $1,000 and an adjusted cost base of $10,000.

The final step is for Tim to simply sell the shares. The $9,000 loss goes on his books, not Susan’s, because he bought the shares from her at fair market value. While this may sound complicated, it really isn’t in practice.

Keep in mind, however, that this loophole applies only to spousal transfers of capital property. In other words, it won’t work if you sell losing shares to another family member or a friend.

RRSP Contribution vs. Mortgage Paydown

Some people feel that it is more important to pay down the mortgage rather than contribute into RRSPs. While reducing your mortgage quickly makes sense, you should recognize that you’ll need a significant nest egg to retire comfortably.

There is a way to accomplish both goals, however. Contribute to your RRSP and use your tax refund to pay down your mortgage. You’ll be building your nest egg and reducing your mortgage at the same time!

Example:

Here’s an example that asks the question: Is it better to pay down the mortgage or contribute to an RRSP?

Certainly, every situation is different and mortgage rates change over the years, but let’s consider this example: Assume a 42% marginal tax bracket and a maximum RRSP contribution room of $12,000. Tax savings from the contribution are approximately $5,040 in this case. This equates to $420 a month of new money that can be applied to the mortgage.

Now let’s assume the $125,000 mortgage is amortized over 25 years and an average interest rate in that period of 6%. Monthly payments are $799.76.

If this is bumped up by the $420 a month in tax savings from the RRSP, the taxpayer cuts the amortization period by 13 years.

The results are the following: Accumulated tax-sheltered earnings on growth of annual $12,000 contributions for 12 years, compounding at a before-tax rate of return of 6% amounts to about $214,600. Interest savings on the reduced amortization period of 12 years rather than 25 years equals approximately $65,300.

Total accumulated principal and earnings in the period will produce net worth of $214,600 in the RRSP and $125,000 in home equity and a further $65,300 in interest savings for a total of $404,900 all from an investment of just $144,000 ($12,000 x 12 years).

7 Key Tax Planning Tips

While tax preparation software can catch most credits and deductions, it’s easy to
overlook them. Here are some of the key reminders for you:

1. Pension splitting
   Your spouse can benefit from pension splitting by using Form T1032-Joint Election to Split Pension Income. Up to 50% of income can be allocated to a spouse or common-law partner, producing a lower overall tax bill and either avoiding or reducing the clawback of Old Age Security (OAS) benefits for one or both spouses. In addition, both spouses may be able to claim the pension tax credit.
2. Expenses
   Some expenses only qualify as tax deductions or tax credits if you pay them before the end of the tax year. Examples include interest costs on investment loans, medical expenses and spousal support payments.
3. Donations
   Charitable donations should also be used to create the greatest possible tax benefit. If a couple has donated more than $200 in the tax year, the receipts should be combined and claimed by the partner with the highest income, thereby maximizing the allowable credit. Don’t forget, you can claim as many as five years’ worth of donation receipts on the same tax return.
4. Tax credits for kids
   Tax credits aimed at children can help parents reduce or eliminate the amount of tax they owe. Child-oriented tax credits you may benefit from include the federal government’s children’s fitness and arts tax credits (both of which will be eliminated for 2017). You may also benefit from the adoption expense tax credit.
5. Child care
   Deductions are available for child care expenses such as daycare and after-school care costs. Costs for boarding school and camp fees may also qualify. Generally, the younger the child, the greater the allowable expense claim limit.
6. Students
   Non-refundable tax credits for tuition, education and textbook costs can also be claimed by a student or their parents or grandparents. Certain types of examination fees will also be considered as part of tuition expenses when claiming the credit.
7. Kiddie tax
   Budget 2014 expanded the so-called “kiddie tax,” making it more challenging to split business income with minor children. The new rules apply to the 2014 taxation year onward. Also known as the tax on split income, these rules tax income at the highest federal tax rate (29%), even if a minor child or spouse is in a lower bracket.

Additional considerations

Finally, if you have a spouse or child with little or no income, there are some good reasons why they should still file a tax return. First, earned income determines eligibility for government programs such as the Canada Child Tax Benefit (CCTB) or the GST/HST credit. Students, especially, should make sure they file a return in order to claim the GST/HST credit. And even a small amount of reported income will add to future registered retirement savings plan contribution room.

Deadline exceptions

The April 30 deadline has exceptions, including for individuals or their spouses who are self-employed or ran a business, or if a spouse died during the tax year. In these examples, the individual has until June 15 to file returns. The Canada Revenue Agency (CRA) allows the extension in these cases because it may take longer to gather the necessary filing information. However, the extended deadline in these instances doesn’t cover the actual taxes owed. They still have to be paid by April 30.

Need Advice?

Reviewing your Tax Plans? We encourage you to talk to us. Speak to your Financial Advisor or contact investor services at 1 800 608 7707.

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10 Tips to Avoid a CRA Audit

Are you actively seeking an audit? Probably not. But if you were, Canada Revenue Agency (CRA) helpfully publishes alerts on its website that identify areas of concern for auditors and warn about actions and investments the agency is likely to investigate. Here are 10 red-flagged practices that could contribute to a CRA decision to audit your tax return.

1. Employment Expenses
   The CRA is paying closer attention to employees who attempt to deduct employment expenses from their employment income. Employees are very limited in the types of expenses they can deduct. Those employees who choose to make a claim can expect questions from CRA.
2. Large Charitable Donations
   The CRA seems to draw the line at cash donations in excess of $25,000, asking for additional information to substantiate the donor’s claims.
3. Allowable Business Investment Loss (ABIL)
   An ABIL occurs when a person disposes of debt or a share of a small business corporation. The advantage of realizing an ABIL over an ordinary capital loss is while capital losses may only be deducted against capital gains, an ABIL may be deducted against all sources of income, including employment income. In order for a loss on debt or equity to qualify as an ABIL, it must meet certain complex and strict rules. When claiming an ABIL, make sure to keep all relevant information that may be required by CRA.
4. Tuition/Education Expenses
   The CRA continues to ask for backup for any post-secondary tuition and/or education expenses claimed on a student’s tax return. Ensure your children keep copies of all tuition slips, especially if the amounts are being transferred to you, the paying parent.
5. Carrying Charges
   While expenses incurred for the purpose of earning investment income (such as interest expense on borrowed money) are typically tax-deductible, it’s essential to keep the necessary supporting documentation and to ensure personal expenses are not being claimed. This is particularly important when interest is being claimed on leveraged investing. If a line of credit (LOC) is used for investing, you must ensure that funds drawn from the LOC are being recorded in detail and not mixed with any personal expenses.
6. Foreign Tax Credits
   If you earn foreign-source income, you must claim any foreign tax withheld as a credit on your Canadian personal tax return. This foreign tax credit can be used to offset any Canadian tax payable and will directly reduce Canadian tax dollar-for-dollar. That said, Deloitte reported that in 2004, the CRA has become much more active in questioning entitlement to foreign tax credits and reviewing taxpayer claims. We can’t emphasize enough the importance of keeping good records, especially foreign tax documents, bank or investment statements that may substantiate any foreign income earned and foreign taxes paid.
7. Child-Care Expenses
   Many organizations provide receipts to parents for services that may not actually qualify for tax relief because their main purpose is not the provision of child care. Examples cited by Deloitte include athletic coaching, music lessons and tutoring. For expenses to be deductible, they “must relate to the overwhelming component of guardianship, protection and child care. Recreational activities were never intended to be included as such an expense by Parliament…” Perhaps the reason for the confusion among some taxpayers is that these organizations often print “for tax purposes” on their receipts, potentially misleading parents into thinking such fees are tax-deductible as child-care expenses.
8. Verification of Capital Gains and Losses
   When you purchase non-traditional investments, such as income trusts or investments in foreign currencies, the calculation of your capital gains and losses can attract unwanted attention. Income trusts pose a unique problem because they often distribute a “return of capital” (ROC), which is tax- advantageous since it’s not currently taxable but rather reduces your adjusted cost base (ACB). You need to keep a record of your ACB adjustments so the correct capital gain or loss can be reported when the income trust is ultimately sold. The other item to watch for when calculating a capital gain or loss is investments denominated in foreign currencies. When these are sold, you must calculate not only your economic gain but also the foreign exchange component of any gain or loss. The foreign exchange gain or loss calculation should be done by comparing the foreign exchange rate on the date of purchase with the rate on the date of sale, as opposed to the average rate for the year.
9. Province of Residence
   As the debate about interprovincial tax planning continues to grow, provincial residency is increasingly an item of scrutiny for the CRA. For example, if you live in a province with a high marginal tax rate, it would be very attractive to take advantage of a lower marginal tax rate in another province. This could be done by acquiring a recreational property in the province with the lower rate, or even by merely establishing a mailing address in the province. Under our tax law, Canadians must pay provincial tax on their worldwide income based on the taxpayer’s residence in a particular province on December 31
10. Mining and Oil & Gas Investments
    There are specialized tax rules governing investments in resource properties. If you choose to invest in such flow-through shares and other resource-based limited partnerships, you may wish to seek professional help come tax time. The CRA often requests additional information on amounts reported on the return when flow-through amounts and tax credits are claimed.

Need Advice?

Reviewing your Tax Plans? We encourage you to talk to us. Speak to your Financial Advisor or contact investor services at 1 800 608 7707.

Download the PDF version of this article

Canadians have heard the lure of self-employment–and they’ve responded. Some three million tax filers now call themselves boss, and the number is growing annually.

If you’re self-employed and your business is not incorporated,
you are responsible for filing an individual tax return each year. Your income must be reported as business or professional income, and you can deduct, or “write off,” your business expenses.

The Canada Revenue Agency (CRA) gives self-employed workers a bit longer to submit their returns each year–the deadline is June 15. But remember, if you owe taxes, interest begins accumulating as of April 30, which is the deadline for individuals who are not self-employed.

Claiming expenses

The CRA allows you to deduct a reasonable amount of the expenses you incur to earn business income. Just be sure to keep your receipts in case you’re audited.

Here are the main deductions you may be eligible to claim.

Business operating costs

Any money spent in the operation of your business–including interest on borrowed money, fees for professional services like accounting, and the cost of office supplies and utilities–is considered a business expense.

For some expenses, like meals and entertainment, you can claim only half the amount spent, or a reasonable portion under the circumstances, whichever is less.

For items with both a personal and a business component, you can claim only the business portion of these costs.

Capital property costs

Capital property covers things you buy in the course of running your business, like office furniture, computer equipment or a building. Over time, you can write them off in the form of depreciation. This is called a capital cost allowance (CCA).

Home office and automobile costs

The cost of having an office workspace in your home can be deducted. To calculate the deductible, start by determining the size of the office space as a percentage of your home’s total size. For example, if your office is 10 square feet and your home is 100 square feet, your office is 10% the size of your home. This means you can deduct 10% of your home expenses, including mortgage interest or rent, utilities, insurance, security monitoring and repairs.

Similarly, if you use your vehicle for both business and personal use, you can deduct a percentage of the costs based on how often you use the vehicle for business.

Should You Incorporate?

As your income grows, you may reach the point where it makes sense to incorporate your business. A rule of thumb is to consider incorporating once your business is profitable enough that you’re covering all your living expenses and have money left over to save and invest.

There are costs to setting up and maintaining a corporation, but these costs can be more than offset by the fact that corporate profits are taxed at a much lower rate than personal income.

By incorporating, you’re also protecting yourself from personal liabilities, which is an important part of creating a sound financial plan for you and your family.

Year-end means the return of winter, the arrival of the holiday season and, like it or not, a certain amount of financial planning.

And that means taking advantage of every deduction and tax credit available to you.

Come tax time, the goal is to pay yourself… not the CRA.

Leaving funds on the table for the government just doesn’t make sense. As we enter the final weeks of 2017, here for your consideration are a few year-end tax tips that could help you keep more money in your pocket: Repay any money withdrawn from your Registered Retirement Savings Plan (RRSP) under the RSP Home Buyers’ Plan.

Repayments must be made no later than March 1, 2018, to avoid taxation. Make any charitable donations you want to claim in 2017. If you have business-related purchases to make, consider doing so before year-end. These may include professional dues and membership fees.

Capitalize on the new $5,500 TFSA contribution limit.

10 Tax Planning Strategies

Here are 10 strategies to consider now – before the end of the year – in order to reap the greatest benefit.

1. Tax-Loss Selling
In times like these, when markets are volatile and investors sustain more than the usual capital losses, tax-loss selling can be a silver-lining strategy. There are several ways to approach this strategy:

IMPORTANT NOTE

One of the most commonly suggested loss-realization strategies for clients who still want to hold an underlying fund is to transfer the fund with the accrued loss to an RRSP. This idea, however, comes with an important caveat – if a fund with an accrued loss is transferred to an RRSP, the loss is denied.

Instead, the fund should first be switched into a money-market fund outside the RRSP.

Next, the money-market fund should be contributed in-kind to the RRSP. The RRSP can then redeem the money-market fund and repurchase the original fund.

In the past, there was no need to worry about the 30-day superficial loss rule because the individual isn’t buying back the same fund – their RRSP is. The 2004 federal budget, however, amended the definition of affiliated, such that a person is now considered to be affiliated with a trust if the person is a majority interest beneficiary of the trust, which would be the case with RRSPs.

As a result, the investor should either wait the 30 days before switching back from the money-market fund to the original fund or consider transferring to another version of the fund inside the RRSP, such as a corporate class fund, if available.

If you want your loss to be immediately available for 2017 (or one of the prior three years), the settlement must occur in 2017, meaning the trade date can be no later than December 27, 2017.

Talk to your financial advisor about these strategies and whether selling or transferring equities is right for you.

2. Estate Planning
Is your will up to date? End-of-year financial housekeeping is a good time to review your will and make sure it represents your current situation and intentions regarding your estate.

3. Registered Plans
If you have any unused contribution room in your RRSP, consider topping it up. (The deadline for 2017 RRSP contributions is March 1, 2018.) If you turned 71 in 2017, you have only until December 30, 2017, to make a contribution to your RRSP for 2017 (but you can include 2017 contributions if you were paid a salary or wage in 2017).

4. Personal Payments
The final tax installment payment for 2017 is December 15th. Parents of children under 16 can claim a non-refundable tax credit of up to $500 for each child registered in an eligible physical activity program.

5. Transit Pass Tax Credit
Provided certain conditions are met, public transit users can claim a non-refundable tax credit.

6. Mutual Fund Purchases
To avoid having to report year-end distributions, consider postponing the purchase of non-registered mutual funds until the new year.

7. Non-deductible Interest on Your Loans
Consider paying off your debt by selling some of your non-registered investments, and then borrowing to replace the investment.

8. Allocating Pension Income to your Spouse
You may be able to increase your after-tax income from your retirement plans by allocating up to one-half of eligible income that qualifies for the existing pension income tax credit to your resident spouse or common-law partner.

9. Stock Option Deferral
Stocks acquired through stock option plans can have the benefit deferred on amounts up to $100,000 in total fair market value (at the time the options were granted).

10. Tax Shelters
Seek professional advice and consult with your financial advisor before investing your money in a tax shelter. The quality of the product is more important than the immediate tax savings.