Chapter 22 - Canadian Taxation
The Canadian Taxation System - Types of Income
4 Main Income Categories in Tax #1 - Employment Income -Wages, salary, benefits -TAXED ON A GROSS RECEIPT BASIS (this means you cannot just deduct any costs incurred to earn this income) --Certain expenses like unions dues, CCP payable, EI, child care expenses are a few allowed for employment deductions #2 - Business Income -income earned from actively producing and selling goods or service -SELF EMPLOYMENT falls under this too (not employment) -TAXED ON A NET INCOME BASIS (the individual is allowed to deduct common expenses to earn that income) --Rent expense, salary expense, COGS (will not go over this in depth within this course) #3 - Income from Property -Interest income, dividends, royalties -Passive type of income solely for the purpose of earning investment income (not actively traded/business like income) --MFs, PFs, stocks, bonds -Rental income is also included #4 - CG/CL -CG/CL is taxed when the disposition is REALIZED (not taxed year by year when value changes) -Taxed in the year realized -Sale Price - ACB - Selling Expense = CG/CL --ACB can be like commission expenses (selling expense) , on top the cost to pay for the stock
Capital Gains and Losses - Overview
ACB Issue -ACB is quite simple in terms of what it means -ACB is complex due to the fact that there are factors that effect how much the ACB is (it not always just the price you bought it at) --It could include commission expenses on purchase and sales of securities --ACB could be different due to you buying the stock at different values but selling them all at once -Overall ACB is Cost of Purchase + Commission Expense When CGs Can Be FULLY TAXED -CGs can be fully taxed when the CRA considers your investment choices as a BUSINESS -Pure speculative investing can be a main determinant in whether the investment is business or CG -When an investor is more SPECULATIVE by the trading action, CRA may argue the investor is speculating and gains should be fully realized (CL fully deductible) Following Factors to Consider for Fully Taxable CGs -Short periods of ownership (day trading) -History of buying and selling and quickly turning over securities -Special knowledge and exp in the securities markets -Substantial investment of time spent on studying the market and finding potential purchases -Financing shares thru margin or other debt -The nature of the share itself (speculative, emerging growth) -Note* --None of these factors alone can fully characterize whether a investor is investing for business reasons (needs to be a combo of factors) How to Avoid Fully Taxed CGs -Aside from the factors above you as the investor should be a CDN resident AND you should not be considered a trader or dealer in securities Dealer or Trader -Taxpayer who participates in the promotion or underwriting of a particular issue of shares or to the public is a dealer in shares -Employee of a corp engaged in this activity is not considered a dealer himself --However if the employee is considered inside trader who legally uses his way to make quick gains then he will be a trader of those shares
Capital Gains and Losses - Disposition of Shares: ACB of Convertible Securities Capital Gains and Losses - Disposition of Shares: ACB of Shares with Stock Dividends or Reinvestment Plans
ACB of Convertible Security -When a security conversion right is exercised, the CONVERSION IS NOT CONSIDERED a DISPOSITION of Property -Thus no CG or Loss is realized -Instead the ACB of the converted stock is now the price of which the original convertible security was acquired at Example -Amy buys 100 P/S for $6,000 -Convertible feature with each P/S (lets you convert 1 P/S into 5 C/S) -Amy exercises this right and converts all P/S to C/S -Amy now holds 500 C/S -ACB C/S = $12 --ACB P/S = $60 ($6,000 / 100) --# of C/S Given Per P/S Converted = 5 Shares --ACB C/S = $60/5 shares = $12 per share ------------------------------------------------------------- ACB of Shares with Stock Dividends or Reinvestment Plans -Regardless if you did not receive cash and instead got a stock dividend or dividend for reinvestment, it will still get taxed as a normal dividend (must declare the dividends IN THE YEAR they are paid) -You should factor in the dividend income into whatever stock ACB you reinvested or have more of thru stock dividends --Why? Because you need to increase the ACB by that much to avoid getting taxed again the dividend you received and now is either a stock or reinvested
Capital Gains and Losses - Disposition of Shares: ACB of Shares with Warrants or Rights
ACB of Shares with Warrants or Rights -Warrants and Rights can be distributed in 3 ways --Thru direct purchase in a market --By owning a share which a right offering is made --By purchasing a unit of securities in which a warrant is attached (sweetener for like a bond) Each Method has its own tax implications #1 - Direct Purchase of Warrants and Rights -Same as for convertible securities regarding tax implications #2 - Rights Received from Direct Share Ownership -Cost Base of the original shares purchased must be adjusted #3 - Unexercised Warrants or Rights -Not all warrants/rights are exercised or sometimes they expire -Investor may even sell them in the open market for CG or CL -If the warrants/rights were DIRECTLY purchased then CL is purchase cost + commission expense (if they expire and are not sold for a gain or offset some loss) -If the warrants/rights were given at ZERO COST then there is not CG or CL (if they expire and not sold) #4 - Warrants and Rights Received at Zero Cost and Then Sold in the Open Market -If sold then the CG is only possible taxation -Anything realized will be taxed as CG
Tax Deferral and Tax Free Plans - Deferred Annuities
Annuity -An annuity is a investment contract through which the holder deposits money to be invested in an interest bearing vehicle Annuity Returns -A portion of it is interest and another portion is the initial capital Deferred Annuity -Immediate annuity the PMTs start right away -Deferred annuity PMTS start at a specified date by the investor in the contract -Both types can be paid in full or deferred can be paid in monthly installments until the start of the PMT period specified -ONLY AVAILABLE THRU LIFE INSURANCE COMPANIES Tax Effect -Annuity do not have tax deduction benefits like RRSP -The annuity PMT contains original principal and a portion is interest --Only the interest is taxed not the capital portion ---UNLESS you buy a annuity with money from a RRSP (since this initial capital hasn't been taxed yet this means the annuity PMT can be fully taxed) ----Most investors buy annuities with a registered account to defer this tax effect Death of Annuitant -If he dies then like RRSP the annuitant is transferred to the spouse otherwise it would just get taxed on the deceased's final tax return --Under certain conditions it maybe taxed under their child or grandchild if named as the beneficiary ---So if the child or grandchild is named the beneficiary they should take the proceeds and transfer it to some registered account
Tax Deferral and Tax Free Plans - Registered Education Savings Plan: Canada Educating Savings Grant
CESG -Incentive to create a RESP -The government will match 20% on the first $2,500 contributed to a RESP each year to a child under 18 -Depending on family income the CESG can be higher than the basic CESG amount -The grant is about $500 to $600 per year depending on family income -This grant is forward straight to the RESP firm and doesn't count towards the lifetime contribution limit -The max life grant amount is $7,200 CESG Repayment -If the child does not goto school then this money has to be returned thru a 20% penalty fee Table 22.8 PG22-25 -Shows us how the additional CESG works -Ex. if you earn under 45.916 as a family you will get a max CESG of $600 each year contributed (if you contribute the max) --Same logic if you make more than 45,916 and less than 91,831 (then its $500 not $600)
Capital Gains and Losses - Capital Losses Capital Gains and Losses - Capital Losses: Worthless Securities
CL -Straight forward just deduct any CL from CGs and carry forward or back any excess -Only applies to CG nothing else -2 other important considerations regarding CL is worthless securities and superficial losses -------------------------------------------------------------- Worthless Securities -When a security is considered worthless the investor must fill out a form from the CRA declaring it worthless (basically no way to sell it and realize the transaction) -This ensures CL will be properly realized for tax purposes -THIS DOES NOT APPLY TO EXPIRY DATE PRODUCTS LIKE warrants, rights, or options --You do not need to go thru hassle of signing a form for these such products Worthless Security EXCEPTION -If the security is worthless due to the underlying company going bankrupt then the investor is assumed to have disposed the security for NIL PROCEEDS AND REACQUIRED AT A COST OF NIL
Tax Planning Strategies - Canada and Quebec Pension Plan Sharing Tax Planning Strategies - Gifting
Canada and Quebec Pension Plan Sharing -The CPP and QPP legislation allow spouses to share their pension benefits -If both agree then the pension benefit can be split amongst both spouses according to length of time they spent together (same household) and the amount they contributed during that time Gifting -If a taxpayer gifts (transfers investment) to adult child or parents, these gifts are considered DEEMED DISPOSITION at the FMV by the person who created the gift -Before giving out any investments as a gift you should factor the CG and CL effect that gift has on your return within the year
The Canadian Taxation System - Tax Deductible Items Related to Investment Income
Carrying Charges -Aka certain expenses a tax payer can deduct on their income their earned from property Types of Carrying Charges -Interest Paid on funds borrowed to earn such investment income and dividends -Fees paid for certain investment advice -Fees paid for MGMT, admin, or safe custody of investments -Account fees paid for the recording of investment income -They are more but these are the common ones Types of Expenses that are NOT CONSIDERED a Carrying Charge -Interest paid on borrowed funds to earn ONLY CGs -Brokerage/Commission fees to buy or sell the security -Interest paid on funds borrowed to contribute to a RRSP, RESP, registered disability savings plan, TFSA -Admin, counselling/trustee fees for a regular or self directed RRSP, or a registered retirement income fund -Financial planning fees -Safety deposit box charges
Tax Deferral and Tax Free Plans - Tax Free Savings Account: TFSA Contributions
Contribution -Contribution is basically any room freed up to contribute into the TFSA -This means that any contribution not used in previous years (unused contributions) can be carried forward --Unused contributions include room freed up by withdrawals made in any but the current year -CRA determines the amount for tax payer and appears on their online CRA profile Contribution Penalty -Anything over he max is taxed at 1% a month Contribution Limit 2009-2012: $5,000 2013 and 2014: $5,500 2015: $10,000 2016-2018: $5,500 Total up to 2018 $57,500 Note* -Contribution room is much less for adults who were 18 much later since inception of TFSA Contribution Example -In 2009 you were at least 18 -If you never contributed then your contribution limit would be $57,500 today Another Example -Lets say you were at least 18 in 2009 -This time you fully contributed every year until 2017 -You chose to withdraw everything in 2017 -You new unused contribution room/limit would be $57,500 in 2018 -Your unused contribution room/limit would be $0 in 2017 since you cannot withdraw then recontribute in the same year unless its unused contribution room (thus you have to wait till next year) REFER TO NEXT FLASHCARD FOR BETTER IDEA OF WITHDRAWING AND CONTRIBUTION IN SAME YEAR
Tax Deferral and Tax Free Plans - Registered Retirement Savings Plan: Contributions to a RRSP
Contributions -RRSP have no limit in terms of how many accounts you can have -Like RPP, the total contribution is limited for all the RRSPs as a whole on a per year basis (having more doesn't increase this amount) Contribution Limit Amount for RRSP? -Lessor of the two amounts --18% of the PREVIOUS YEARS earned income --RRSP dollar limit for the year Additional Calculations Required to The Limit Amount -Deduct the previous years PA and current years PSPA -Add the taxpayers unused RRSP contribution room at the end of the immediately preceding taxation year Contribution Deduction Deadline -Must be made in the taxation year or within 60 days after the end of the year to be deductible in the taxation year RRSP Unused Amount Carry Foward -This amount is carried forward forever Example -Tax year is 2018 -Mario had $70k of earned income in 2017 -On his 2017 T4 tax form he had a PA of $5,400 -No PSPA in the current year -No unused contribution room -No previous year RRSP over contribution -His max deductible contribution to an RRSP for the 2018 year is as follows --Lessor of $12,600 (18% of $70,000) or $26,230 (2018 RRSP contribution limit) --> he picks $12,600 ---Now we must subtract the PA to get $7,200 ($12,600 - $5,400) ----OVERALL - Mario can contribute a tax deductible amount of up to $7,200 at most to his RRSP in 2018 tax year
Tax Planning Strategies - Discharging Debts
Discharging Debt -Attribution Rule does not apply if a tax payer directly discharges the debt of his or her spouse, or minor, or some non arms length individual -Tax planning wise a person with a lower income can thus borrow money from a third party, which the higher income earner repays (Non Arms Length - Related) Example -Amy low tax bracket earner borrows 20k to buy a truck -Her wife Lakshay is a high earning analyst -Lakshay assumes the debt and pays it offer with her income -Amy now has freed up capital that she can now invest and earn a return in with a low tax bracket (Lakshay does not have to make a return at a high return now)
Capital Gains and Losses - Disposition of Fixed Income Securities Capital Gains and Losses - Disposition of Fixed Income Securities: Accrued Interest
Disposition of FI Securities -Sale or redemption of FI securities by investors (NOT TRADERS since they fully taxed) often produce a CG or CL What are FI Securities Under ITA? -Bonds -Debentures -Bills -Notes -Mortgages -Hypothecs -Similar Debt Obligations --Note* Some debts do not even have a market (savings bonds) so the price doesn't fluncatuions which implies no possible CG/CL ------------------------------------------------------------- Accrued Interest -Like equity, FI CG are found by finding proceeds of sale - ACB (ACB = purchase cost + expenses of sale) -During the time of sale interest may have accrued --This accrued interest is not included in the CG, instead it is interest income for the VENDOR at the date of sale --The purchaser (issuer or another investor) can now DEDUCT that accrued interest amount they received when they report their income on tax return (Again since it accrued amount at the date of sale was for the vendor) ---Why? Investors who are selling debts are legally allowed to claim interest income until the point of sale (includes accrued interest) ---What happens if the interest payment is in 1 month but the investor is selling right now? The new purchaser now has the duty to pay the accrued amount for the last 5 months and they get to keep the 1 month of interest for that semi-annual period Example -Amy buys $10,000 principal amount 5% semi-annual bond at par in the interest PMT month -Amy buys it from another investor -This implies that Amy will have to pay the seller the accrued interest for the last semi-annual period -Lets say Amy has to pay Lakshay the seller $200 in accrued interest at the point of sale/purchase -Amy's Total Cost for Bond = $10,200 (NOTE* THIS IS NOT THE NEW ACB ITS STILL $10k) -Tax Effects --Lakshay (Seller) ---includes $200 of fully taxable accrued interest (this amount also would've included any other interest received from new bond owner Amy) ---includes a CG or CL using $10,000 as the selling price --Amy (Buyer) ---Amy would include the other $300 from the semi-annual PMT in her fully taxable interest income ---When Amy decides to sell the ACB IS $10,000! NOT $10,200
Capital Gains and Losses - Disposition of Shares Capital Gains and Losses - Disposition of Shares: ACB of Additional Shares
Disposition of Shares -ACB = Cost of Security + Commission Expense Example -Amy buys 100 $6 per share and pays $17 commission on transaction -Amy then sells 100 shares at $10 with additional commission of $25 on transaction -CG = (100 * $10) - (100 * $6) - $17 - $25 -Taxable CG = 358/2 = $179 ------------------------------------------------------------- ACB of Additional Shares -Average Cost Method --This is when a individual has bought the same stock at varying stock prices and now has to sell some or all shares --ACM = Total Cost/Total Shares Example -Amy buys 200 $6 per share in January 2019 with a $25 commission -Amy buys 100 more at $9 per share in June 2019 with a $20 commission -Average Cost Method --Total Cost = $2,145 --Total Shares = 300 --ACB using ACM = $7.15 per share
The Canadian Taxation System - Taxation of Income From Property: Dividends from Taxable Canadian Corporations
Dividends from CDN Corps -Focus in this chapter will be on public CDN Corp Shares -Dividend tax credit (DTC) is given when you invest in a publicly traded CDN Company Gross Up -Avoids the double taxation since Corps have to pay dividends from after tax amount -The investor will get a dividend and get to gross it up to what the Corp would've earned before tax and then take a tax credit that offsets the amount of tax the corporation paid so dividend system avoids paying excess tax Eligible Dividends -Grossed up by 38% to arrive at the taxable amount of dividends (pre tax income amount the Corp roughly would've had) -Tax credit would be 15.02% (2018 figure) which offsets any tax on that gross up (this tax credit is the amount the corporation paid for the taxes on that net income paid for that dividend amount) Provinces DTC -some do given them Example -Lakshay gets $1,000 in E-Dividends -Gross up 38% = $1,380 in gross up amount -Lakshay will claim a income of $1,380 in his tax return -Later Lakshay will offset that gross up tax by getting a 15.02% tax credit ($207.28 = GROSS UP NUMBER ($1,308 * 15.02%) -Thus Lakshay will pay no tax on the corporate taxed amount and pay tax on whatever his marginal rate is -Marginal rate is 20.5% --Tax Payable = 282.90 --Tax Credit = $207.28 (offsets corporate taxed amount) --Net Tax Payable = $75.62 ---Basically the higher your marginal rate the more you pay Tax Forms -T5 is a form that shows what they must report on their tax return regarding the investment income they made -T5 tax form shows the gross up and DTC -Sent annual to SH -The dividend paying corp will provide the T5 -Investment dealers who hold shares in STREET NAME will issue the T5 form to the beneficial owner Stock Dividends and Dividends Reinvested -Treated just like a normal cash dividend tax wise
The Canadian Taxation System - Taxation of Income From Property: Dividends from Foreign Corporations The Canadian Taxation System - Taxation of Income From Property: Capital Gains and Losses
Dividends from Foreign Corps -Taxed like any normal regular interest income -Individuals will receive a net amount from the Non-CDN source -Non residents who receive CDN income may be able to offset it with foreign tax credits --this credit is the lessor of foreign tax paid or CDN tax payable on foreign income -------------------------------------------------------------- CG/CL -Straight forward -Taxed when realized -CL only offsets CG -50% of CG taxed
Capital Gains and Losses - Capital Losses: Superficial Losses (2/2)
Example -Amy buys 100 shares at $30 per share on April 15 -She sells the shares at $25 per share on May 1 -CL = $500, as of now this loss is allowed -The following two scenarios is where the CRA would not allow this loss to be CL deductible #1 -May 15 Amy repurchases 100 shares of the same company at a price close to $25 per share and holds it until July -This purchase took place within the 30 day superficial period (30 days after loss sale May 1) -She also keeps the shares past the last day of the original loss sale (still owned at the end of 30 days after original loss sale) -This all applies as a superficial loss, meaning this is not considered a deductible CL for tax purposes -Amy may be able to add the non deductible loss to her ACB when she sells the shares in July to reduce CG effects #2 -April 29 before the May 1 loss sale, Amy buys another 100 shares near the initial $30 per share price -May 1 the stocks fall to $25 per share and now she sells off 100 shares (still has other 100) for $25 per share ($500 loss) -Other 100 shares are held until July -Now she has repurchased the same shares 30 calendar days before the loss sale and she also held the same shares 30 days after the original loss sale -This creates a superficial loss -Amy may be able to add the non deductible loss to her ACB when she sells the shares in July to reduce CG effects Scenario where superficial loss is added back -Amy lost $500 on May 1st -We know she bought 100 more shares for $25 per share -This $5 per share loss ($500 / 100 repurchased) would be added to the ACB of the repurchased shares ($25 + $5) -So now if the shares are sold at $40 when she sells them in July the CG per share is $10 ($40 - $30) instead of $15 ($40 - $25) also deducting for any commission fees
Tax Planning Strategies - Splitting Income Tax Planning Strategies - Transferring Income
Income Splitting -Process of taking income from a high tax bracket tax payer and transferring it to a low bracket spouse, child, parent -Tax laws have made it more difficult to do -Spousal RRSP are the best investment vehicle to split income -Other options include trusts, partnerships, small business corps, investment holding companies (professional advice is recommended for this) --------------------------------------------------------------Transferring Income -Transferring income to another family member can trigger ATTRIBUTION RULE -If property or income producing assets are transferred from the tax payer to other family members the tax consequences of those assets maybe passed back to the tax payer -Marriage breakdown/divorce is a common exception to the attribution rule Attribution In Depth -If a spouse transfers a asset to a family member for a less than FMV then there is a deemed disposition attributed back to the transferor -If the transfer is made by way of a loan, the loan must bear interest --If the rates are less than the prescribed rates by the CRA than a interest benefit needs to be taxed --Interest should be paid within 30 days after the particular year to which it relates
Tax Deferral and Tax Free Plans - Registered Retirement Savings Plan: Over Contributions Tax Deferral and Tax Free Plans - Registered Retirement Savings Plan: Contribution in Kind Tax Deferral and Tax Free Plans - Registered Retirement Savings Plan: Withdrawals from a RRSP
Over Contributions -Over contributions can be made without a penalty of up to $2,000 (just not deductible in the year) -After that you may be imposed a penalty of a 1% tax per month that exceeds the $2k -------------------------------------------------------------- Contribution In Kind -Process of adding assets that you already own to your RRSP -If you do add the assets the ITA deems this as a disposition --THUS CG OR CL MUST BE CALCULATED and included in the income tax for the year realized ---POD is the FMV of the asset Example -Amy bought 100 shares of ABC at $10 2 years ago -Value = $1,000 -The shares are now $2,000 FMV aka $20 per share -She owns a self directed RRSP which allows her to contribute in kind -She chooses to add these assets to the RRSP -She must now deem disposition per the ITA and recognize a $1,000 CG or $500 Taxable CG in the year realized/contributed in kind -------------------------------------------------------------- Withdrawals from RRSP -Again RRSP is a trust account designed to benefit the holder at retirement -Once withdrawn they are subject to tax within the year -They might have to pay more tax depending on the marginal rate of the holder and how well or bad they did the planning Home Buyers Plan/Lifelong Learning Plan -Generally the only time you can withdraw from a RRSP prematurely is for the purpose of buying a home or for school. The holder must eventually return the funds -Certain conditions must be met to avoid penalty and repayment back to RRSP right away NOTE* -YOU CANNOT withdraw funds from an RRSP for the purpose of using the cash for collateral
Tax Planning Strategies (Title) -Identify some basic tax planning strats and stats for minimizing tax liability
Overview Splitting Income Transferring Income Pay Expenses Making Loans Discharging Debts Canada and Quebec Pension Plan Sharing Gifting
The Canadian Taxation System -(Title) -find differences between interest, CG/CL, and dividends
Overview Calculating Income Tax Types of Income Taxation of Income Taxation of Income from Property -Interest Income -Dividends from Taxable CDN Corporations -Dividends from Foreign Corporations -Capital Gains and Losses -Minimizing Taxable Investment Income Tax Deductible Items Related to Investment Income
Capital Gains and Losses (Title) -Calculate investment gains and losses
Overview Disposition of Shares -ACB of Additional Shares -ACB of Convertible Securities -ACB of Shares with Stock Dividends or Reinvestment Plans -ACB of Shares with Warrants or Rights Disposition of FI Securities -Accrued Interest Capital Losses -Worthless Securities -Superficial Losses Tax Loss Selling
The Canadian Taxation System - Overview The Canadian Taxation System - Calculating Income Tax
Overview -Federal government impose taxes by the federal statue under the ITA -CDN provinces have their own statues on their residents (and non residents) who have business/perm establishment Collector -Federal government collects for themselves and provinces, except --Alberta (administer own taxes on corps) --Quebec (administer own taxes on corps and individuals) Location -Companies that incorporated in Canada are to be considered CDN tax payer -Foreign companies that also have MGMT and control in Canada are considered CDN tax payers -Individuals who reside in Canada also pay taxes on foreign income (account for international tax treaty) -Individuals who reside somewhere else may be applicable for taxes from CDN government from CDN source income ------------------------------------------------------------- Calculating Income Tax -All tax payers must calculate their income tax -Individuals use calendar year -Corps can use ANY FISCAL YEAR (has to be consistent year over year) --Fiscal year can only be 53 weeks long --This means they can pick a date to pay but just stay constant and within 53 weeks 5 Steps in the Income Tax Calc #1 - Calculate all sources of income (NITP) #2 - Allowable deductions which helps you arrive to taxable income #3 - Calc the gross or basic tax payable on taxable #4 - Claim allowable tax credit on tax payable #5 - Calculate the net tax payable
Tax Deferral and Tax Free Plans - Pooled Registered Pension Plans
PRPP -Offered by federal gov (your employer needs to participate in this in order to be part of it) -Designed to address the gap in employer pension plan coverage by providing CDNs with an accessible, large scale, low cost pension plan -PRPPs hold assets from multiple participating employers -The benefit is that the employee can benefit from the low investment cost since the pension plan is much bigger overall with a bunch of employers working together to reduce cost/burden of running it by themselves PRPP Administered -They are offered by financial institutions like banks and insurance companies -Overall this way it reduces the overall risk and cost that employers would normally bear for retirement plans for employees Who can qualify for a PRPP? -Employed or self employed in the 3 territories -Those work in a federally regulated business or industry for an employer who chooses to be in the PRPP instead -Those who live in a province that has the required provincial standards legislation in place Other Facts -PRPP can be designed where members can just make their own investment decision or select from investment options provided by the plan administrator --Options including varying risks and rewards Contributions -LIKE RRSP, PRPP are limited to contribution room based on EARNED INCOME and contributions ARE TAX DEDUCTIBLE
Tax Planning Strategies - Paying Expenses Tax Planning Strategies - Making Loans
Paying Expenses -Sometimes you need to evaluate who is paying what expenses -For example a high tax bracket spouse should be paying majority of the expenses to reduce tax costs, while the low bracket spouse invests their money to make a return (this will generate a larger return for the family as a whole) ------------------------------------------------------------- Making Loans (reread PG22-28) -Attribution rule does not apply when a interest rate is at the prescribed rate when making a loan and paid within 30 days after year end -Good tax planning is where a investment is expected to make a earning in excess of its prescribed rates, the high income member should loan to the lower income member money to invest that investment --The excess made over the prescribed rates will then be taxed on the low tax bracket member
The Canadian Taxation System - Taxation of Income From Property The Canadian Taxation System - Taxation of Income From Property: Interest Income
Property Income Tax -Income from property is taxable in the year earned EXCEPT for property income that was received from a registered plan (deferred or avoided) -Property income is taxed on a ACCRUAL BASIS (tax is usually cash basis so rmbr this) --This means that regardless if you got cash that year if the dividend, rental property, etc made income distributed to you then its taxable Example -Since PROPERTY INCOME IS TAXED ON A ACCRUAL BASIS -We know zero coupon bond there is no interest instead you are given a one time return at maturity -Zero coupon bond is taxed like property income -Since property income is accrual basis -The income earned from the zero coupon bond annually is still taxed even though that income will be cash ready at maturity -------------------------------------------------------------- Interest Income -Compensation received by a lender for the use of the funds they lend -Fully taxable at the marginal rate REGARDLESS IF INVESTMENT IS CASHED WITHIN YEAR OR ACCRUED AT WITHIN YEAR (zero coupon example) -Accrued interest does have the capability of being deferred for no more than a year (tax planning idea0
Tax Deferral and Tax Free Plans - Registered Retirement Savings Plan: Qualified and Non-Qualified RRSP Investments
Qualified RRSP Investment Products -Money deposited in a bank or similar institution -GICs -Gov Guaranteed Bonds -Shares and debt obligation of CDN public companies -Shares of a foreign public corp listed on a prescribed stock exchange -Foreign GOV bonds with good investment grade ratings Non-Qualified RRSP Investment Products -Securities that are from privately held corps (unless certain conditions are met) -Real estate (real estate investment trust units are exceptions) -Commodity and financial future contracts -Real property like artwork, jewelry, rare manuscripts, and stamps Note* -These are some of the few of many qualified and non-qualified
Tax Deferral and Tax Free Plans - Registered Education Savings Plan (1/2)
RESP -This is a tax deferred savings plan intended to help pay for the post secondary education of a beneficiary -Contributions are not deductible for tax -Beneficiary is the one who gets taxed on the returns -The withdrawal happens provided the beneficiary is going to school of some sort -Before that the investment is generally accruing a return before the beneficiary starts school -The idea of the RESP is that once the beneficiary starts school they will be in a low tax bracket while the contributor will be in a higher one --Therefor when they withdraw to pay for school the beneficiary who's responsible for paying the return/yield tax (not the initial capital invested) will be in a low bracket when getting taxed RESP Max Contribution -Lifetime max allowed is $50,000 per beneficiary -This can be one lump sum or consistent PMTS up to 31 years -The plan must expire within 35 years of its starting date
Tax Deferral and Tax Free Plans - Registered Pension Plans (1/2)
RPP -Trust organization registered with either the CRA or a provincial tax agency -These plans are designed by companies to help their employees with retirement by providing pension benefits -Both the employer and employee contribute and both can deduct the amount paid from any tax effect Contribution -Most savings plans allow you to contribute a level 18% of earned income towards retirement with a max dollar amount per year Pension Adjustments -Process of determining the value of the contributions made to your registered plan or of the benefit accruing to you -PA reduces the amount a taxpayer can contribute to a RRSP -PA goal is to imposed a annual contribution limit which shall not be exceed on plans -PA is reported on a plan members T4 Tax Form Past Service Pension Adjustment -Employers make upgrade pensions plans for employees within certain limit -They do this by making changes to current plans or introducing new plans -Thus the employer can make more contributions to the plan -This difference between the old plans and new plans PA is called the PSPA (the additional amount) -PSPA also reduces the amount an employee can now contribute to their RRSP Carry forward -Investors do not have to contribute the max amount on all plans combined within the year -Any amount no contributed is excess and can be carried forward as a RRSP CARRY FORWARD ROOM --Allows for investors to make up for the room and not lose the contribution opportunity
Tax Deferral and Tax Free Plans - Registered Retirement Income Funds
RRIF -Is a tax deferral vehicle available to RRSP holders who wish to continue to shelter their assets from tax within their plan -RRSP transfer the assets to a RRIF along with the earnings made -RRIF does have rules tho --under a RRIF you must start withdrawing a fracation of the total assets within the RRIF over time --the RRIF holder will pay tax on this MINIMUM ANNUAL WITHDRAWAL AMOUNT How is minimum withdrawal amount calculated? -Factors that effect how much minimum is, is designed by the CRA to ensure benefits are provided to the holder until death -For example CRA usually base the minimum on either the holders age or the spouse of the holder's age (whoever is younger) --In this case the term can be long and minimum amount could be less What happens if you start a RRIF before 71? -So before reaching 71, the annual minimum amount that must be withdrawn is a percentage based on the persons age. Calculated as follows -- Minimum % = 1 / (90 - Age) ---So it would start at 5.28% (71) and ends at 95!! which is then set at 20% Example -Amy is 65 and transfers her RRSP to RRIF last year -RRIF is valued at $200k -Minimum % = 1 / (90 - 65) = 4% -Withdrawal is then $8000 at the least (no max amount take as much as you want) RRSP and RRIF similarities -Both RRSP and RRIF are not limited to one account you can have multiple of them -Both RRSP and RRIF can be self directed or managed with a variety of investment products
Tax Deferral and Tax Free Plans - Registered Retirement Savings Plan
RRSP -RRSP is a tax deferral plan -You can make a limited contribution and deduct that amount from your tax return for deferred tax -Anything within the account that is made in terms of interest, CG, dividends, etc is not taxed or realized until you withdraw -Withdrawal is taxed like how the income would've been if it had not been in a RRSP (withdrawal taxed within year withdrawn) Two Types of RRSPS #1 - Single Vendor Plans -The holder of a single vendor invest in one or more GICs, segregated pooled funds, or MFs -Investments are held in TRUST under the plan by a particular issuer, bank, insurance company, credit union, or trust company -The holder themselves do not get to make the day to day investment decisions -Trustee fee is common under this plan on top of whatever common fees you see with whomever you work with #2 - Self Directed Plans -These are investors who invest funds or add certain acceptable assets like securities directly into the plan -The plans are usually administered for a fee by a CDN financial service company -In this type of plan, while its administered by a CDN financial service company, the plan itself is managed by the holder itself -They are rules on what can be under this plan but a variety of options are given
Tax Deferral and Tax Free Plans - Registered Retirement Savings Plan: Advantages of RRSPs Tax Deferral and Tax Free Plans - Registered Retirement Savings Plan: Disadvantages of RRSPs
RRSP Advantage -Tax deduction advantage during high earning years -Certain lump sum payments maybe transferable to RRSP sheltering from additional tax -Savings within the RRSP can earn a compound interest on a tax free basis until its withdrawn -Income taxes are basically deferred until later years when the holder is older and in a lower bracket and can be taxed less -Spouses have the ability to split retirement income which provides two advantages --Lower taxation if each takes a certain amount --The opportunity to claim two $2,000 pension tax credits RRSP Disadvantages -Regardless if its a CG, the entire amount withdrawn is taxed fully, no CG benefits or nothing -RRSP ARE NOT ELIGIBLE FOR DTC FROM A CDN CORP -If the RRSP holder dies and no beneficiary is labelled, the entire amount is taxed in the deceased's final tax return and allocated to the estate (no beneficiary no free tax transfer benefit) -The assets of an RRSP cannot be used as a collateral for a loan (just like how you cannot withdraw from RRSP for the reason of using the money for collateral for a loan)
Tax Deferral and Tax Free Plans (Title) -Describe the types of tax free and tax deferral plans
Registered Pension Plans Registered Retirement Savings Plans -Qualified and Non-Qualified RRSP Investments -Contributions to a RRSP -Earned Income Eligible for RRSP Contributions -Over Contributions -Contribution In Kind -Withdrawals from a RRSP -Spousal Registered RRSPs -Withdrawals from Spousal RRSPs -Other Types of RRSP Contributions -Termination of RRSP -Advantages of RRSPs -Disadvantages of RRSPs Registered Retirement Income Funds Deferred Annuities Tax Free Savings Account -Basic TFSA Rules -Taxation of TFSA -Qualified Tax Free Savings Account Investments -TFSA Contributions Registered Education Savings Plan -Canada Educating Savings Grant Pooled Registered Pension Plans
Tax Deferral and Tax Free Plans - Registered Retirement Savings Plan: Other Types of RRSP Contributions Tax Deferral and Tax Free Plans - Registered Retirement Savings Plan: Termination of RRSP
Some Pension Income can be transferred directly to RRSPs without affecting the regular tax deductible contribution limit. The following are some #1 -Lump sum transfers from RPP and other RRSPs directly into the holders preferred RRSP (as long the transferred funds were not included in income and no deduction arises from transfer) #2 -Allowances upon retirement for each of service (aka retiring allowance) are transferable ----------------------------------------------------------- Termination of RRSP -RRSP can be fully withdrawn or terminated at any time -Deregistration aka termination is mandatory at the age of 71 What can do the 71 year old RRSP holder then? -Withdraw the lump sum amount and get fully taxed on all of it at once -Use the proceeds to buy a life annuity -Use the proceeds to purchase a fixed-term annuity (providing benefits to a certain age) -Or transfer the proceeds to an RRIF which provides annual income What happens if RRSP holder dies before termination? -Beneficiary will transfer the proceeds, into their own RRSP tax free -Beneficiary is usually the spouse or common law, or under certain rules it can be the child or grand child -If no beneficiary is able to transfer the proceeds of the deceased then it will be taxed in the deceased's income in the year of death and transferred to his estate for allocation
Tax Deferral and Tax Free Plans - Registered Retirement Savings Plan: Spousal Registered RRSPs
Spousal Deduction -Taxpayer who also contributes to their spouses RRSP may claim that contribution deduct for themselves -RRSP must be registered in the name of the spouse or common law -MAJOR NOTE* This amount contributed must still fall within the contribution limit of the contributor --So regardless of that fact that he's contributing to his spouse, he still has the same contribution limit Example -Lakshay and Lakwinder are married and contribute to separate RRSPs -Lakshay has a max contribution of $11,500 for the year -He may contribute the entire amount to his or Lakwinder's RRSP or he may allocate the amount between his and his spouse RRSPs to share the wealth -As long as he remains under his contribution limit -This means that if Lakshay lets say added $1,500 to Lakwinder plan this will not effect Lakwinder's RRSP contribution limit so he can still make his contribution amount fully, but Lakshay now has $1,500 less in max contribution amount due to contributing to Lakwinder's account
Capital Gains and Losses - Capital Losses: Superficial Losses (1/2)
Superficial Losses -This event occurs when a security is sold at a loss and then repurchased again within 30 calendar days BEFORE or AFTER the loss sale and are still owned at the end of 30 days after the original loss sale --Why does this matter? Superficial losses are not tax deductible as CL --Why do this? CRA can prevent taxpayers from purposely selling and then repurchasing assets solely for the purpose of creating a deductible CL --Is there still hope? Yes superficial losses can sometimes be partially recovered and are just deferred for the mean time. Most of the time when the remaining repurchased shares are sold the amount of loss from original sale is added to ACB of the repurchased shares thereby reducing the CG Superficial Losses ALSO APPLY TO PEOPLE AFFILIATED WITH THE INVESTOR, this includes -Investor's spouse or common law partner -Corporations controlled by the INVESTOR OR SPOUSE -A trust in which the investor is a majority interest beneficiary Superficial Losses Do NOT Apply The Following -Investor emigrates from Canada -The investor dies -An option expires -A deemed disposition by a trust occurs -The securities are sold to a controlled person (not you) (Deemed Disposition - where the ITA will consider a disposition has occurred even though no sale was made)
Tax Deferral and Tax Free Plans - Tax Free Savings Account Tax Deferral and Tax Free Plans - Tax Free Savings Account: Basic TFSA Rules Tax Deferral and Tax Free Plans - Tax Free Savings Account: Taxation of TFSA Tax Deferral and Tax Free Plans - Tax Free Savings Account: Qualified Tax Free Savings Account Investments
TFSA -Deposits are after tax no deductions -Any returns made are tax free -Withdraw any time no penalty or anything -Withdraw whatever amount and use for whatever -Contribution limit like RRSP is still applicable ------------------------------------------------------------ Basic TFSA Rules -Any CDN Resident at least 18 can open a TFSA employed or not -Contributions can come from any source (unlike earned income where it needs to be specific) ------------------------------------------------------------- Taxation of TFSA -Contributed amounts are not tax deductible like RRSP -Any income CG, interest, dividend, whatever is tax free and will not be charged a withdrawal tax ------------------------------------------------------------- Qualified TFSA Investments -GICs -Savings Accounts -Stocks -Bonds -MFs
The Canadian Taxation System - Taxation of Income From Property: Minimizing Taxable Investment Income
Tax Benefits from Income -Dividends from CDN CORPS and CGs will always be subject to better taxation than interest income which is always fully taxed -Thus if you shift from a interest paying investment to a dividend paying CDN stock you may be able to reduce taxes for a higher return Table 22.4 AND 22.5 PG 22-7/8 -Shows us how interest, dividends from CDN, and CG get taxed -Note how type of income and marginal rate is what varies how much tax you pay
The Canadian Taxation System - Taxation of Income
Tax Brackets -Federal have their own -Each province has their own as well -Adding both gives the tax payer a COMBINED MARGINAL TAX RATE -Margin Tax Rate is the rate at which the tax payer must pay for each additional dollar earned Example -Lakshay earned 150k -Not Correct but lets say tax brackets were -15% on first 40k -20% on the NEXT 50k -26% on the next 50k -29% on next 10k -Total = 150k -His MARGINAL TAX RATE is 29% -If he earned $1 more then that $1 will get taxed in the next bracket and new marginal rate would be determined
Tax Deferral and Tax Free Plans - Overview
Tax Deferral Plan -Helps defer income until a later date, and with good tax planning you can defer income in a certain year to avoid additional margin tax rates (better return overall) -Most plans are created because the CDN government want people to save for retirement Tax Free Plan -Plans like TFSA allow you to withdraw any income you made within the plan without a tax effect -The money added in is usually after tax -There is a limit to the tax free amount withdrawn as well
Capital Gains and Losses - Tax Loss Selling
Tax Loss Selling/Planning -Tax loss is not always bad it can actually be used for tax planning and better future -For example lets say your client has money invested in a stock that has no plan for appreciation in the future -You and client agree to take a CL on the stock -You then use this CL to deduct any CG (reducing tax amount) -You then use the tax savings and whatever proceed you made from the CL to reinvest in more certain and attractive securities Tax Loss Selling Requires You To Consider The Following Factors Before Doing Anything #1 -if your client plans on repurchasing the same share after selling at a CL, you have to make sure it doesn't fall under superficial loss #2 -Regardless, we know that settlement (T + 2) is the day the ownership is officially switched -This is important because if your client chooses to sell at the end of year and take a CL, this CL will not apply until next taxation year in early January
Tax Planning Strategies - Overview
Tax Minimization -There's a reason why its a secondary objective for many clients because tax shouldn't always be the main focus -Sometimes event the highest taxed product will bring in a higher return over a low taxed product -Tax overall shouldn't be the sole objective -Best effort regarding tax is where a advisor is where tax planning is done early and often --This is because tax planning is a ongoing process with many matters to address in the year Tax Minimization is Done Through The Following -Make full use of allowable deductions -Convert non-deductible expenses and try to make tax deductible expenses -Postpone the receipt of income -Split income with other family (done under certain conditions) -Select investments that provide the better after tax return (don't make this a main focus other things like safety of capital, steady income, and growth are important) Note -Various strats will be listed below, but its always good to remain updated and find other strats to ensure you are on top of your tax planning
Tax Deferral and Tax Free Plans - Registered Education Savings Plan (2/2)
Two Types of RESPs #1 - Pooled RESPs -Pooled plan allows the contributor to make a contribution for their beneficiaries -The pooled fund is managed for you by a plan administrator -Annual contributions to the plan are generally pre set -At maturity the administrator will determine the amount paid out to the beneficiaries #2 - Self Directed RESPs -administered by many institutions like banks, MFs, investment brokers -Contributions are not generally pre set and are flexible -Contributors participate in both the investment and distribution decisions RESP Family Plans -Where there is more than 1 beneficiary -Ex. if one child doesn't pursue school then the other child is able to take all the income instead of having to pay a 20% penalty tax RESP Withdrawals -RESP can only be withdrawn for the following two reasons --The plan has been existence for more than 10 years and none of the named beneficiaries has started a qualified program by Age 21 --All beneficiaries have died -Contributors are allowed to transfer a max of $50,000 of RESP income to their RRSP (providing enough room) tax free --Obviously the contributions will be withdrawn tax free --Any extra income earned from the contributions will be taxed fully when withdrawn AND PENALTY TAX OF 20% FOR NOT USING THE RESP (this 20% is the savings grant the government provided) Contributor Withdrawals -If the contributor starts to withdraw instead of the beneficiary then the RESP must be terminated by February of next year
Tax Deferral and Tax Free Plans - Registered Pension Plans (2/2)
Two Types of RPP #1 - Money Purchase Plan -Aka defined contribution plan -Contributions are set at a FIXED AMOUNT -Benefit amount at retirement depends all on how much was invested over the plans life -CONTRIBUTION LIMIT FOR MPP --Combined contribution by the employer and employee must be the lesser or two amounts ---18% of the employees current year compensation ---The MPP Contribution Limit #2 - Defined Benefit Plan -DBP benefit amount unlike the MPP is determined based on a formula that considers --years of service --income level --and other variables ---Overall the contribution need to be set at a level necessary to fund the preset plan benefits -Unlike MPP, the DBP contributions amount is deductible BASED ON THE ACTUARY estimated amount (this is enough to properly fund the plan) -Current DBP limits are designed to provide employees with a maximum pension of 2% pre-retirement earnings per years of service (indexed for inflation) -Overall the actual benefits the employee gets are based on the term of the pension plan -Regardless the DBP also has a contribution restriction, which are the lessor of two amounts --9% of the employees compensation for the year --$1,000 plus 70% of their PA for the year
Tax Deferral and Tax Free Plans - Registered Retirement Savings Plan: Earned Income Eligible for RRSP Contributions
What goes in Earned Income? -Total Employment Income (less union or professional dues) -Net Rental Income -Net Income from Self Employment -Royalties (from published work and Inventions) -Research Grants -Some alimony or maintenance payment ordered by a court (spousal support for example) -Disability PMTs from the CDN Pension Plan (CPP) -Supplementary Employment Insurance Benefits (ex. top up payment from a employer to his employee who is on parental leave) Note* -Employment insurance benefits from Employment and Social Development Canada are not included
Tax Deferral and Tax Free Plans - Registered Retirement Savings Plan: Withdrawals from Spousal RRSPs
Withdrawal - Spousal -The tax effect may be on the spouse or the contributor depending on the time of withdrawal Taxable to the Contributor -If the RRSP withdraws money within the year its contributed OR from the last 2 most recent year, the contributor is then taxed -Contributor is only taxed up to amount CONTRIBUTED NOTHING MORE --So if he gave 0 the whole 3 years then he doesn't get taxed or if he gave 2k and she withdrew 3k he only gets taxed on the 2k he contributed Taxable to the Spouse -If the RRSP withdraws money after 3 years or more (this avoids the last 2 recent years and the current year funded) it is taxed to the spouse Interest Earned from RRSP - Spousal -Regardless when the withdrawal happened any interest earned from the contributions will always be taxed to the spouse regardless of withdrawal date Example -Year is 2020 and I contributed $0 to my spouse -2019, 2018,2017,2016 I also gave $1k each year -Interest was $800 accrued until 2020 -In 2020 my wife chooses to withdraw $5k from the RRSP -I will get taxed on a TOTAL AMOUNT OF $2k --Why? Because that's how much of my contribution affected her RRSP (2020 = 0, 2019 = 1k, 2018 = 1k) -My wife will have to pay $3,800 --Why? The $3k is the amount that's passed the ITA rule and per the ITA the SPOUSE MUST COVER THE INTEREST ACCRUED aka $800 Note* -Spousal RRSPs ARE NOT TAXED when converted to a RRIF or purchase of a certain acceptable annuities
Tax Deferral and Tax Free Plans - Tax Free Savings Account: TFSA Withdrawals
Withdrawals -Withdraw anytime (withdraw amount doesn't change current year contribution room, that gets updated next year) -No limit -No penalty or tax -Withdrawals can be re-contributed if you wanted, just not in the same year unless you had unused contribution room before you made the withdrawal (if so that would be the limit until next year) -Dave and Zo both withdrew 10k from their TFSA in 2017 for rent -Dave had still $14k in unused contribution room he hadn't used -Zo did not have any left and max out his contribution limit up till now -Dave and Zo both decide its better to redeposit the $10k they both had. -Dave has $14k of unused contribution room so this is not a issue (once he deposits he can only redeposit or deposit $4k worth of funds in the same year) -Zo on the other hand has $0 worth of unused contribution room. This means that he cannot deposit any of his $10k until next year where he will have in 2018 yearly limit of $5,500 and $10,000 from the withdrawal from last year as unused contribution room Overall -TFSA is good for any type of goals and life stages --School, repayment of student loans, new car, down PMT for a house, whatever