Taxation 

Individuals and corporations are required to file annual income tax returns. Income tax is levied by the federal and provincial governments. Provincial tax rules do not necessarily reflect the federal tax rules and regulations.

 

The federal Income Tax Act and regulations (ITA) are one of the most complex pieces of Canadian legislation and are recorded in 2,900 pages in the Income Tax Act. The ITA touches on most aspects of Canadian life. Because of the complexity of the ITA professionals can only specialize in certain parts of the Act.

Minimizing total tax paid is one of the more important factors to consider when planning for retirement. Using an advisor with significant tax knowledge and experience and, who uses a model that has a strong tax component, is essential. The average person lacks the tax knowledge needed for retirement and estate planning.  

Topics on key tax issues.  

#1 Taxation of cryptocurrencies 

#2 Income tax - Instalment payments

#3 Carry-forwards and Refundable and Non-refundable Tax Credits

#4 OAS - starts the month after you turn 65 - not always!  

#5 Interest and Carrying charges 

#6 Dividends are not all treated the same for tax purposes

#7 Deferred Property Tax - A gift from the provincial government

#8 "An honest mistake" -  CRA penalties may still apply 

#9 RRIF Minimum withdrawal rates 

#10 Registered vs Non-registered accounts + refundable vs non-refundable tax credits

#11 TFSA Contribution limits by year 

#12 Tax Minimization straegies? -- it depends

#13  Prescribed Loans - another way to split Income

#1 Taxation of  Cryptocurrencies

While cryptocurrencies are very popular and have been around for several years the tax treatment is still evolving.

 

One of the appeals of cryptocurrency is that can be used to conceal illegal activities or hide income from the taxman. Given the large sums of money involved, it is just a matter of time that government tax agencies like CRA try to ensure all such income is reported. In the process, they will also decide what constitutes income and their interpretation of how it will be taxed.

 

Regulators and the taxman are however struggling to keep up with the development and spread of cryptocurrencies but-- trying hard. 

 

There is a limited amount of information available about taxes and cryptocurrencies in Canada.  A limited summary of the basics is outlined below (from CRA sources).

 

  1. Cryptocurrencies are considered securities: they are not treated as cash.

  2. CRA considers cryptocurrencies to be a ‘commodity’: income is treated as business income.

  3. The tax treatment depends on whether transactions are in the nature of business (to earn income) or as an investment.

  4. Accepting cryptocurrencies as a payment is considered to be ‘bartering’ bus1inesses that accept this type of payment for products or services must report it as income. 

  5. In most cases, business cryptocurrency transactions are income in the year g the transaction.

  6. The tax treatment of cryptocurrency ‘mining’ (when paid in cryptocurrencies) also depends on the nature of the transaction – see (3).

  7. If the nature of the transaction is not obvious (provable/justifiable) CRA would likely treat it as income.

  8. The issue of ‘business’ vs. ‘investment’ income is often ambiguous and depends on many direct and indirect factors such as timing, frequency, ‘intent’ etc. CRA makes the call!

  9. If a transaction is an investment, gains or losses are treated as capital transactions and taxed accordingly (50% taxable or deductible in Canadian dollars).

  10. Taxable capital gains and losses are given capital gains or loss treatment allowed under the ITA. The rules applicable to ‘superficial’ losses also apply.

  11. Tax is payable in the year of the disposal of a  cryptocurrency.

  12. “Disposals” of cryptocurrencies include trade or exchanges, conversions to hard dollar currencies, or as payment for any type of goods or services.

  13. The values of purchases or disposals or redemptions etc. must be stated in Canadian dollars on the date of the transaction.

  14. You must keep detailed records of any type of transaction in order to establish the cost or selling price of a cryptocurrency.

  15. The cost or selling price is the fair market value of the cryptocurrency based on the cost of whatever was purchased or sold (a potential can worms).

  16. Where a taxable service, product, or property is exchanged for a cryptocurrency GST/HST applies at the time of the transaction.

  17.  If cryptocurrency transactions are not reported CRA may impose penalties and charge interest on unpaid taxes.

Summary

Cryptocurrencies and transactions are complex: they are a bookkeeping nightmare from a tax perspective. The fact that the tax treatment is still evolving makes it difficult to decide what information you may need to have for tax purposes in the future. Given the notoriety of cryptocurrencies as havens for illegal activities and tax evasion, the policing authorities and CRA will monitor transactions closely increasing the risk of being audited. Since cryptocurrencies are a global issue governments will co-operate with each other and the latest technology will be applied to discover 'illegal' transactions. There is more risk involved with cryptocurrencies than simply losing money!

See  #7 under Investments  - Tax avoidence vs. tax evasion 

Gerry Wahl, Managing Director, The PensionAdvisor    

#2 Income tax - Instalment payments

CRA requires that quarterly tax installments must be made on March 15, June 15, Sept. 15, and Dec. 15 if “net tax owing” this year is more than $3,000 and, was greater than $3,000 in the 2 previous years. The net tax owing is the net federal and provincial taxes, less income tax withheld at source.

If you are an employee and your job is your main source of income, you do not have to make installment payments. If however, you are self-employed, you are required to make installments payments based on your net income, net rental income, investment income or, realize capital gains in non-registered accounts. If self-employed, installments must include CPP contributions and voluntary EI premiums.

CRA may send a reminder when installments are due. Interest and penalties may apply if the installment payments are not made, or are late. 

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#3 Carry-forwards and Refundable and Non-refundable Tax Credits

'Carry-forwards' and Refundable Tax Credits (only) can be used to reduce future tax payable 

Tax Deductions 

There are  certain deductions that can be carried forwards indefinitely, if not used, that can be used in future years to reduce taxable income

a) capital losses and allowable personal capital losses (back 3 years as well)

b) business losses (back 3 years),

c) used tuition fees and textbook costs ( have to be used in a year when you pay income tax)

d) unused RRSP and pension contributions

e) Canadian exploration expenses (mining) 

f) 'flow through'  Investment tax credits (shares on certain equity investments)

g) interest on qualified student loans (Canada Student Loans Act) etc.

h) qualified moving expenses 

i)  TFSA room (not deductible but can be carried forward) 

Some carry-forward deductions are included in the Notice of Assessment.  

Refundable Tax CreditsRefub=dable TaRefundable Tax Creidirty

Unused Refundable Tax Credits can be claimed in a future year to reduce tax payable. The credits may be 'scaled' to income levels and may change from year to year. Each credit also has different qualifications so you have to check before trying to claim - there is no simple rule. 

a) Adoption expense tax credits 

b) R&D credits  (up to 20 years forward)

c) GST & HST tax credits

d) Working Income tax credit 

e) Child Care tax credit  (if low earned income)

If you have zero taxable income or no tax owing you can apply for refundable tax credits and get a refund.

Don't be too quick to claim the deductions or tax credits: there may be an advantage in delaying the claim to the future. A financial plan with a strong tax model will help select the optimal year to claim the deduction and/or credits to reduce overall tax paid, particularly if a significant future taxable income event is expected.  

 

 

Non-Refundable Tax Credits and deductions 

Must be claimed in the year. If they are not used they are forfeited. Examples: basic personal deduction, eligible dependent deduction, medical expenses, pension income deduction, CPP and EI premiums Federal Personal Amount tax credit, Old Age tax credit, etc. In some cases it may be advantageous pay tax by deferring deductions to utilize the non-refundable tax credits.  msg

Non-

 

#4 OAS - starts the month after you turn 65 - not always!  

The application for OAS is automatic but you can also defer it

Qualifications for OAS: 1) the year you turn 65,   2) Canadian citizen, and  3) you lived in Canada for at least 10 years since age 18.

OAS is subject to income tax.  There is also a clawback of OAS starting if the current year includes a net income of $78,845 (2021). The OAS is completely eliminated when net income is $129,260 or more (2021). 

When you turn 65 - you don't have to apply for OAS- it is automatic (unless you didn't get it -OMG!), You can also defer OAS up to 5 years and get a larger amount in a later year (@0.6% per year deferred). You can request a deferral online via your CRA's "MY Account", or by writing CRA.

 

The OAS benefit you receive will increase by 5.9% starting January 2022 and by a further 10% in July 2022, in addition to the regular scheduled quarterly OAS adjustments.

 

Most people understand they will get OAS the month following their birth month -this is correct. However, if your birth month is between January and June of the year you will not get an OAS payment until July of the year. CRA doesn't make the first OAS payment until it gets the tax return for the previous. CRA does not make retroactive OAS payments for the months the benefit was not paid. There are millions of people over the last 20 years who have been done out of 1- 5 months of OAS benefits (say ~$500 per month or ~$2,500 if it was for 5 months).  

This is an arbitrary CRA 'administrative' policy: it is not legislated or in the regulations. There is no information about this CRA 'policy' on the  CRA website or on the internet.  It is discriminatory, based on age, and a bithdate, and has been challenged in Court. 

G.Wahl, Managing Director, The PensionAdvisor

#5 Interest and Carrying charges

Interest expenses can be deducted in some cases. 

A key point to remember is interest costs incurred to borrow money to provide funding for a registered pension account, TFSA or another type of tax-deferred account are not deductible for tax purposes. 

You can claim the following if incurred to earn income.

  1. Fees to manage investments.

  2. Fees for certain investment advice.

  3. Fees paid for preparing a tax return.

  4. Interest paid to earn investment income from interest and dividends.  

  5. Equity loans where the company indicates they will pay dividends in the future.

  6. Legal fees incurred relating to support payments to a current or former spouse. 

  7. Interest on student loans (claim on Line 31900 only)

        You cannot claim certain expenses.

  1. Interest to borrow money to contribute to one of the registered savings accounts or a TFSA.

  2. Safety deposit box fees.

  3. Brokerage fees paid to buy securities (included as part of the cost of the security).  

  4. Legal fees to get a divorce.

#7 Deferred Property Tax - A gift from the provincial government

Deferring annual property tax -  an opportunity to preserve cash and monetize home equity 

 

It's not often the BC government provides a significant benefit but deferring your annual property tax is definitely a gift. Qualifying homeowners (see below) can defer the property tax (only) portion of their annual tax assessment (this does not include the lesser utilities charge or other local add ons). Interest is charged at a very low rate - usually much less than bank loan rates. The deferred tax, in simple terms, is a loan. 

Alberta, Ontario, and Halifax also allow property taxes to be deferred. 

Some people do not take advantage of this because they don't like having any form of debt, or they don't want to be subsidized by a government (actually not possible - you 'own' a portion of government debt and you get many forms of government subsidies).  The loan balance will grow very slowly and the future appreciation in the home's value will likely more than offset the loan balance. From a financial and risk perspective, it makes sense to defer property tax.   

How it works

The provincial government pays the city (municipality) the property tax and sets up a loan account for the amount. The balance owning is a lien again the property and will be paid when the property is sold, or if pay back the loan (any time). 

The province does charge interest on the balance owing but at a very low rate. Historically, the interest rate is well below bank loan rates, and less than inflation.

To qualify for this program, you must:

  • Be a Canadian citizen or permanent resident of Canada

  • Be a registered owner of the property

  • Have lived in B.C. for at least one year prior to applying

  • Pay property taxes for the residence to a municipality or the province

  • Have paid all previous years' property taxes, utility user fees, penalties, and interest

You must also be either:

  • Aged 55 or older this year (only one owner must be 55 or older any time during the current calendar year)

  • A surviving spouse of any age who isn't currently the spouse of another person

  • Designated as a person with disabilities under the Employment and Assistance for Persons with Disabilities Act

  • A person with disabilities and, in the opinion of a physician, your severe mental or physical impairment:

    • Is likely to continue for at least two years

    • Directly and significantly restricts your ability to perform daily living activities, either continuously or periodically for extended periods, and

    • As a result of those restrictions, requires you to have an assistive device, the significant help or supervision of another person, or the services of an assistance animal to perform those activities

Property qualifications

To qualify for this program, your eligible property must:

  • Be your principal residence (where you live and conduct your daily activities)

  • Be taxed as residential (class 1) or residential and farm (class 1 and 9)

 

Equity requirements

You must have and maintain minimum equity of 15% of the property's assessed value. This means that all charges registered against your property plus the amount of taxes you want to defer can’t be more than 85% of the BC Assessment value of your property in the year you apply.

If you have a secured debt on your property, such as a mortgage or a line of credit, contact your lender before you apply to ensure your approval into the tax deferment program doesn't conflict with the terms of your loan.

 

When you may not be able to defer your property taxes

Contact your lender prior to applying to ensure approval into the program does not conflict with the terms of your loan.

If there's an option to purchase on the property title, the property may not qualify for deferment. Contact us for more information before you apply.

G.Wahl, Managing Director, The PensionAdvisor 

#8 "An honest mistake" -  CRA penalties may still apply 

"honest mistakes' when filing do not exempt you from  penalties  

Neither CRA or the Courts appear to be very sympathetic about applying penalties in the case where a taxpayer makes an honest mistake in filing a tax return. The Canadian tax system is based on 'self-assessment" and an unintentional error in filing a return CRA will result in a penalty being assessed even if you subsequently correct the error. 

CRA can waive the penalty in the case where a reasonable error. However, misunderstandings or not knowing the requirements and regulations is not a reasonable error. This interpretation does leave much room for the taxpayer to avoid penalties given that most taxpayers have a very limited understanding of the ITA. 

If the penalty is to be removed it would have to be proven that CRA was not reasonable i.e., did not have a coherent and rational understanding of the reason for the error in relation to the facts and ITA. The hurdle the taxpayer's faces is proving the unreasonableness of the CRA's decision to file a penalty, not the fact that it was an innocent error that was made.  

The onus is on the taxpayer to follow the rules under the ITA when filing a return. A taxpayer is expected to be aware of the rules in the Income Tax Act  (ITA) - if not seek advice.

This doesn't mean CRA won't waive a penalty but it's probably going to be a bit of an uphill battle getting them to do this.

G.Wahl, Managing Director, The PensionASdvisor

#9 RRIF Minimum withdrawal rates  

If you have RRIF you are required to withdraw a minimum amount each year 

1) The minimum is withdrawn at the end of a year if you haven't done so already by the carrier.

  

2) Tax is only withheld if you withdraw more that minimum amount during the year.

3) Withdrawals are include in income for the year and tax is payable when you file the return. 

4) The withdrawal rate may be different in certain situations and can be found at

https://www.canada.ca/en/revenue-agency/services/tax/businesses/topics/completing-slips-summaries/t4rsp-t4rif-information-returns/payments/chart-prescribed-factors.html

#10 Registered vs Non-registered accounts + refundable vs non-refundable tax credits

Definitions and common tax terminology that may be confusing 

1) Registered accounts  - savings and pension type   accounts 

      * a tax assisted savings account such as an RRSP, RRIF, LIRA, RLIF, TFSA etc 

      * tax is not applicable to income or gains when earned - but - there are also no 'tax breaks'

      * When money is withdrawn from these accounts it is 100% taxed at your marginal tax rate 

2) Non-registered accounts  - regular investment accounts 

      * regular investments accounts a with a broker or other carrier  

      * tax is applicable to income or gains when it is earned not when it is withdrawn  - but - there are 'tax breaks'

      * Dividends qualify for the non-refundable dividend tax credit and only 50% of capital gains are taxed

      * Interest income is 100% taxed at your marginal rate in the year earned

3) Non-refundable tax credits  

      * there are many types of non-refundable tax credits

      *  non-refundable tax credits must be used in the year or they are lost - can not be carried forward or back to another year 

      * cannot be used to create a refund 

 

4) Refundable tax credits  

      * there are several refundable tax credits

      * refundable tax credits can be used in the year or carried forward indefinitely and used in a future year to reduce tax payable

      * cannot be used to create a refund 

5) Marginal tax rate   

      * income is taxed at different rates - i.e., lower rates for lower taxable income but increase as income increases 
      * 'marginal tax rate'  is the (last) rate applied to an additional $1 at the taxable income level - it increase as you move into a higher tax                     bracket income

 

                    Playing poker without understanding t he rules is a recipe for losing  

G.Wahl, Managing Director, The PensionAdvisor 

#11 TFSA Contribution limits by year 

TFSA a gift from the Government -  savings account not a pension account 

The annual TFSA dollar limit for the years

2009 --> 2012 -  $5,000.

2013 --> 2014 - $5,500.

2015 -->         -  $10,000.

2016 --> 2018 - $5,500.

2019 --> 2022 - $6,000.

1)The TFSA annual room limit will be indexed each year to inflation and rounded to the nearest $500.

2) Total lifetime TFSA contribution Limit is $81,500 to the end of 2022. 

3) In the year you open a TFSA you can contribute the (cumulative) maximum.

4) Investment income earned by, and changes in the value of TFSA investments will not affect your TFSA contribution room for the current or future       years.

5) You can make an annual TFSA contrition any time during the year.

6) You can take money out of a  TFSA anytime during the year and then repay it a future year.

7) If you take money out of the TFSA and want to put all or part of it back in you must wait until the next year to do this. 

TFSA’s are intended as a short-term savings account (effectively, a bank account) vs. a long-term pension savings account. Short-term investment strategies require a different investment approach and investments than a long-term strategy. The level of risk and the time horizon are different and the investment options in a CAP may not accommodate ta short-term approach. The type of communication and education are also different  - a reason for sponsor not to offer a TFSA.  

However, a TFSA  can also used as part of a long-term saving program. 

 

G.Wahl, Managing Director, The PensionAdvisor  

 

#12 Tax Minimization strategies?  .... it depends 

 

Tax minimization is not a simple or straightforward exercise: it depends on many diverse factors.

While the government offers diverse ways to minimize tax payable the approaches are not equally effective or appropriate.

 

There are two types of employer and individual tax-assisted (tax tax-differ) pension approaches: Capital Accumulation Plans (CAPs) and Defined Benefit Plans (DB). Capital Accumulation Plans (CAPs) include Defined Contribution (DC), Pooled Registered Pension Plans (PRPPs), Registered Retirement Savings Plans (RRSPs,) and Tax-Free Savings Accounts (TFSAs). CAPs fall under the Income Tax Act vs. federal or provincial pension legislation and CAPSA Guidelines. DB and DC plans are established and governed under federal and provincial pension legislation, as well as the Income Tax Act (ITA).

 

The ‘tax savings’ programs are actually taxed ‘deferral’ programs i.e., eventually, tax has to be paid. Any ‘tax savings result from the tax reduction (‘saving”) in a specific year vs. the tax that will have to be paid in the future. The underlying assumption is that your marginal tax rate in the future will be less than the current year hence the ‘tax saving.” However, it is not that simple – there are many things to consider. Various common tax-saving vehicles are discussed below.  For example using a particular approach may increase your taxable income and either result in or increase an OAS 'clawback' - undermining your overall objective.  

 

An effective tax minimization strategy wills change with time and as circumstances change. Having a comprehensive up-to-date financial plan, with a strong tax component, is essential in selecting an effective approach.

Tax Free Savings Accounts (TFSA)

A TFSA allows you to contribute a prescribed amount annually. A TFSA is like a bank account – it is flexible, convenient, and the most effective and simplest way for most people to minimize tax.

 

Pro’s:

· earnings, gains, etc., for the year are not taxed

· Money can be withdrawn at any time without limit

· Withdrawals are not taxed

· Withdrawals can be put back into the TFSA in any following year

· The account can invest the money in a variety of investment vehicles

 

Con’s

· Contributions are not tax-deductible

· Not protected from creditors (unless the account is with an insurance company)

· Retirement income not guaranteed.

· Onus is on the account owner to invest the funds

 

Defined Contribution (DC), Pooled Registered Pension Plans (PPRPs)

DC plans and PRPPs are established by employers for employees. Both the employer and employee may make annual contributions (to a maximum set each year by CRA). DCs and PRPPs are convenient and flexible for both the employer and employee. The employer however has a fiduciary responsibility to the plan members which entails potential legal and financial risks (a known unknown). These types of accounts are an effective way to save for retirement and reduce taxes.

 

Pro's:

· Earnings, gains, etc., for the year are not taxed

· Employer contributions are taxable but offset by a deductible for employer and employee   contributions

· Money in DC or PRPP may not be withdrawn unless allowed by the plan

· The contributions are automatic – a form of forced saving if employee contributions are required

· Protected from creditors

· The account can be invested in a variety of investment vehicles

· Onus and performance are on the account owner to invest the funds

· Portable – can be transferred to another employer, or financial institution, if you change jobs or when you retire

· The employer has a legal fiduciary role and responsibility to the plan members

 

Con’s

· Earnings, gains, etc., are 100% taxed when withdrawn (at the marginal tax rate)

· The savings are usually locked until retirement age

· Forced saving despite financial circumstances

· For the employer, the fiduciary role is onerous and entails possible legal and financial risks

· Retirement income not guaranteed.

· Onus is on the account owner to invest the funds effectively


Registered Retirement Savings Plans (RRSPs)

An RRSP can be set up by individuals or by employers for employees as part of their retirement

benefit program. The employer and employee may be required to make annual contributions (to a maximum set each year by CRA). The employer however has a fiduciary responsibility to the plan members which entails potential legal and financial risks (a known unknown. RRSPs are convenient and flexible for both the employer and employee but may not be the best option to minimize tax over time.

 

In the case of solvency, an RRSP could be exposed to a creditor if a court order is obtained. This depends on each province’s rules for non-bankruptcy and circumstances.

 

Bankruptcy protection, at the federal level, is provided for RRSPs, RRIFs, RDSPs, and deferred profit-sharing plans (DPSPs). For provinces and territories without creditor protection, federal legislation protects registered plans from creditors if the annuitant declares bankruptcy.


Bankruptcy protection usually does not apply to contributions made within 12 months of declaring bankruptcy or, within 5 years if insolvent. Bankruptcy law also considers contributions made in the previous five-year period if the annuitant or account holder was bankrupt or anticipated declaring bankruptcy. (Creditor protection does not apply if the creditor is CRA.)

 

Pro’s:

· Earnings, gains, etc. for the year are not taxed.

· Employer contributions are taxable but offset by a deductible for the employer and

employee contributions

· Money in RRSP in an employer program may not be withdrawn unless allowed by the plan

· The contributions to an employer RRSP are automatic – a form of forced saving

· Protected from creditors in many cases

· Portable – can be transferred to another employer or service provider if you change jobs

· The employer has a legal fiduciary role and responsibility to the plan members

· The account can be invested in a variety of investment vehicles

 

Con’s

· Earnings, gains, etc., are 100% taxed when withdrawn (at the marginal tax -usually higher)

· The saving in an employer RRSP may be locked until retirement age

· Forced saving despite the financial circumstances of an employer RRSP

· For the employer, the fiduciary role is onerous and entails possible legal and financial risks

· An RRSP must be converted to an RRIF at the age 72

· RRIF withdrawal rules apply

· Retirement income not guaranteed.

· Onus is on the account owner to invest the funds effectively.


RRIFs. LIRAs, and LIFs

RRIFs, RRIFs, LIRAs, LIFs, etc., are similar in most respects to an RRSP. They are held as separate accounts through a financial institution bank. In some cases, a sponsor may allow employees who retire or terminate to remain in the pension programs, however, this results in additional, and not insignificant financial and legal risks and, administration costs for the sponsor. RRIFs LIRAs and LIFs are ‘locked into’ specific rules and requirements under the ITA.

 

Pro’s:

· Earnings, gains, etc., or the in the year are not taxed

· Employer contributions are taxable but offset by a deductible for employer and employee contributions

· Money in RIFF, LIRA, LIF in an employer program may not be withdrawn unless allowed by the plan

· The account can be invested the money in a variety of investment vehicles

· Protected from creditors

· Portable – can be transferred to another employer or a service provider if you change j jobs

· The employer has a legal fiduciary role and responsibility to the plan members

 

Con’s

· Contributions are not allowed except for transfers from a DC, PRPP, or another RRIF are generally higher)

· The saving in an employer RRSP may be locked until retirement age

  Contributions are not allowed except for transfers from a DC, PRPP, or another RRIF Minimum annual   withdrawals are required at age 72 (withdrawal rate is set by CRA)

· Forced saving despite financial circumstances in an employer RRSP

· The sponsor’s fiduciary responsibilities are onerous and entail possible legal and financial risks, and costs.

· Retirement income not guaranteed.

· Onus is on the account owner to invest the funds


Principal Residence

A principal residence is traditionally considered a good way to increase net worth (savings) while avoiding tax on any gain, and you need a place to live. If you sell, however, you may be forced to buy so the ‘net’ wealth outcome can be in question there are also costs, often overlooked, that reduce the actual gain.

 

Pro’s:

· Any gain, if the house is sold, is not taxed.

· The principal residence often appreciates in value.

· There is no requirement to sell

· Money can be borrowed, using the house as collateral, and invested.

 

Con’s

· There are costs involved in maintaining or renovating a principal residence

· Location and market timing are potential risks – known unknowns

· Continuing to own a house may result in a person being asset rich and cash poor

· Losses on the sale of a principal residence are not tax-deductible


Regular (Non-registered) Account – Investment Strategies

The earnings and gains made in a regular (non-registered – non-pension type accounts) are taxed each year, at the current tax rates. The advantages of having investments in a non-registered account are significant and can result in the total tax paid, over a lifetime, is minimized. The advantages of having investments in a non-registered account are often overlooked when there is a focus and enthusiasm to minimize current (short-term) tax payable.

 

There are three types of security type investments available in savings accounts: 1) dividends, 2) capital Gains, and 3) interest income. Each of the investments is treated differently for tax purposes and which may result in a lower effective tax rate. Bear in mind that all withdrawals from registered accounts (pension accounts) are 100% taxable at your marginal tax rate.

 

1) Capital Gains – The sale of shares, bonds, options, and other financial vehicles, real property, personal property, rights, etc., during the year, will usually result in a capital gain or loss and must be reported for tax purposes. These disposals receive special tax treatment resulting in lower tax payable. Capital gains are an effective way to minimize tax in non-registered investment accounts or avoid tax in a TFSA.


The taxable amount is only 50% of the selling price less the cost (the Adjusted Cost Base - ACB) and is included in income and taxed at the marginal income tax rate. If a loss is realized from the disposition, it can only be deducted against capital gains of the current year, the past 3 years, or it can be carried forward and deducted against capital gains of a future year. Some capital type investments are only redeemable or sold at cost e.g., shares of certain mortgage companies, hence there is no capital gain or loss.


If there are frequent dispositions of an ‘investment’ CRA may deem these transactions to be income vs. capital gains and include them in taxable income. The intent when acquiring an ‘investment’ is important and must be supportable.

 

Investing for capital gains is an effective way to minimize tax. It is commonly used in non-registered accounts or for ‘personal’ property and investment etc. not held in registered (pension type) accounts. However, gains or income of any type (capital gains, dividends Interest income) in a non-registered account is taxed as income when withdrawn from the account and taxed at your marginal tax rate.

 

2) Dividends – are received from investments of shares in certain companies. Dividends are taxed in the year received but receive special tax treatment. In Canada, the dividend amount received from a Canadian publicly-traded company is grossed up by 138% and included in taxable income. However, an offsetting, non-refundable tax credit of 15.02% of the grossed-up amount is calculated and used to reduce tax payable. The net effect is that dividends are taxed at a lower rate than regular income i.e., at a rate similar to capital gains. Dividends are an effective investment strategy to minimize tax in non-registered investment accounts and avoid tax via a TFSA.


Investing for the purpose of earning dividends is a common strategy to generate retirement income in registered (pension type) accounts. However, dividends in a registered account are treated as taxable come when withdrawn from a registered account and taxed at your marginal tax rate i.e., the only tax advantage in having dividend income in a registered account is the potential delay (the year the income is withdrawn) to pay tax.


3) Interest Income – is earned on investments in bonds, GICs, Notes, mortgages, mortgage investment corporations, bank accounts, etc., All interest, from any source and or type of account, is included in income, in the year received, or when withdrawn from a registered account, and at the marginal tax rate. Interest on bonds, GICs, and other types of investments must be included in income in non-registered accounts on an accrual basis vs. when received. There are exceptions: interest on compound interest bonds, GICs, etc., however, is not taxed until redeemed or sold e.g., Canada saving bonds, GICs, provincial bonds, municipal bonds, etc.


Interest rates on government bonds, GICs, and bank accounts tend to be lower than the income from other investments. Investors often choose certain interest-type investments for safety and/or regularity and frequency of payments.


Having interest-type securities in a TFSA account avoids tax and provides investment ‘security.’ otherwise, interest income is not an effective way to minimize tax.


 

Defined Benefit Plans (DBs) – in some cases - forced saving

Some employers offer DB plans as part of their remuneration and benefits programs. The contribution and the benefits can be in the form of a flat benefit (usually union) plan, or a salary-based (non-union plans). The employer deducts contributions in the year paid. The employee does not pay tax on contributions: the employee only pays tax when pension payments are received.

 

In some cases, an employee is required to contribute to the DB plan: these contributions are tax deductible-type of forced savings; however, it may not be an optimal investment strategy for the funds contributed.

 

While DB plans provide a guaranteed level of retirement for an employee, and usually their spouse, they are not risk-free. DB plans must always be adequately funded in order to be able to pay benefits. If the employer becomes bankrupt or cannot fully fund the DB plan the benefits will be reduced.

An Individual Pension Plan (IPP) is available to small business owners and professionals. It is similar to a B+DB and offers DB benefits and other advantages to the beneficiaries.


DB sponsors usually offer Capital Accumulation Plans as part of the benefits to provide a way for employees to augment their retirement income. In doing this, the sponsor takes on additional financial and legal risk and administrative costs.


Summary

Selecting an effective tax minimization strategy is not a simple or straightforward exercise. The approach is unique for each individual and requires a comprehensive understanding of retirement objectives, investments, investing, and tax law. The only efficient and effective way to minimize tax is with a formal, comprehensive financial (retirement) plan that has a strong tax component, and an experienced advisor.

 

G. Wahl, Managing Director, PensionAssistant

pensionadvisorywahl@gmail.com

#13 Prescribed Loans - Income splitting approach

A prescribed loan can be used used to split income for high tax bracket earners 

Prescribed loans are interesting but complex and can be awkward to administer. They can be used for a high-income tax bracket person to lend money (for investment purposes only) to a family member to earn (only) investment income.

 

The prescribed interest rate also applies to late payments on tax owed to CRA or, money CRA owes you.

A key feature of a prescribed loan is that the interest the lender must charge is the rate at the time in which the loan was initially made. The interest paid on a prescribed rate loan entered into on or before Oct 1, 2022 for example will be 3%, even if the prescribed rate goes up in the future. This is another way to split income with a spouse or child.

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The prescribed interest rate used for certain types of loans between related persons increase from time to time - it recently creased from the current 2% to 3% on Oct 1, 2022. It represents the minimum interest rate the lender must charge (and report for tax purposes) and is payable and tax deductible by the borrower.