Chapter 25: Canadian Taxation

A superficial loss

- securities sold at a loss & repurchased within 30 calendar days. Loss NOT tax deductible. - this extends to trades by spouse, corp controlled by investor &/or corp controlled by spouse... - the amount of superficial loss is added to repurchase cost of shares, therefore, reduces ultimate capital gain.

Contribution rules for RRSPs

- max deductible contribution = 18% of previous years income or RRSP dollar limit for year, less, previous years PA & current years PSPA, plus, unused room at end of last year - unused room can be carried forward indefinitely

What is the penalty for RRSP over contributions?

- no penalty if under $2,000 - over $2,000: 1% per month of over contributed amount

What is the penalty on over contributions to a TFSA?

- penalty tax of 1%/month on excess contributions

Marginal tax rate

- rate paid on any additional dollars of taxable income earned - federal rate + provincial rate = combined marginal tax rate

Advantages of RRSPs

- reduced taxable income in high tax years though contributions - tax free growth of retirement assets - income tax deferral - opportunities to split retirement income with spouse (SPL RRSP)

Taxation of interest income

- reported on an annual accrual basis, regardless of if cash is actually recieved

Tax deferral plans

- tax payment deferred until retirement when income & tax rates are normally lower - e.g. RPPs, RRSPs, RRIF's, TFSA's, RESP ..

Taxation of dividends from foreign corporations

- taxed as regular income (like interest income) - may get foreign ta credit to offset Canadian tax payable

How is employment income taxed?

- taxed on a gross receipt basis - employees can deduct a few employment-related expenses such as pension contributions & union dues, but not all related costs to earn income

Interest payable on borrowed funds is only deductible if;

- taxpayer has legal obligation to pay interest or - purpose of borrowing funds is to earn income or - income produced from securities purchased is not tax exempt

Spousal RRSPs

- the taxpayer contributed to an RRSP in their spouse's name & can still claim the deduction - withdrawals are taxable income to spouse - NOT contributor - taxed to contributor if withdrawal made in year of contributions, or 2 years prior to withdrawal

What can RRSP holder do at 71?

(a) withdraw proceeds as fully taxable lumpsum (b) use proceeds to purchase a life annuity (c) use proceeds to purchase a fixed-term annuity which provides benefits to a specific age (d) transfer proceeds to RRIF (e) a combination of the above

Taxable capital gains =

(gross proceeds from sale) - (ABC - Comission) X (1/2)

Money Purchase Plans

- aka defined contribution plans (DCP) - contribution predetermined & retirement benefit dependent on how contributions are invested - combined employer/employee contributions cannot exceed lesser of (a) 10% of annual income or (b) MPP contribution limit.

Defined Benefit Pension Plan (DBP)

- benefits predetermined based on a formula; years of service, income level ... - contributions = those necessary to fund predetermined plan benefit - max pension = 2% of pre-retirement earnings per year of service - contribution limited to lesser of (a) 9% of annual income or (b) $1,000 + 70% of employee's PA for year.

Pension Adjustment

- contributions made to, or value of benefits accruing to an employee, from registered plans. This reduces the allowable contribution to RRSPs

Minimizing Taxable Investment Income

- depending on marginal tax rate dividend income may be greater than capital gains, or vice versa - dividend income & capital gains are always better than interest income

ACB of rights or warrants

- depends on how shares were acquired - direct purchase in market: same ACB as w/ convertible securities - rights received from direct share ownership: ACB of original shares purchased - when not exercised: if directly purchase capital loss = purchase cost + commission. If acquired at 0 cost gain/loss=0. - if right/warrants are received at 0 cost & sold in market full sale value = gain

Pooled Registered Pension Plans (PRPPs)

- designed to address gap in employer pension plan coverage by providing Canadian with large-scale, low cost, accessible pension plan - reduces cost & risk employers normally bare when offering a retirement plan for employees

Taxation of dividends from taxable Canadian corporations

- dividends grossed-up to equal approx. what the corp would have earned before tax. Taxpayer receives credit to offset tax already paid by corp - gross up = 38% - credit = 15.02% of grossed up amount

Canada Education Savings Grants (CESGs)

- federal government matches 20% of first $2,500 contributed per year for children under 18 - additional grants are available if family income is less than $44,000/yr - maximum lifetime grants = $7,200 - grants must be repaid if child does not attend post-secondary

Business Income

- from profits earned from producing/selling goods/services. - taxed on a net-income basis

Capital Gains & Losses

- gain/loss from sale of capital property. - costs of sale or disposition are included in gain/loss

Self-Directed RRSPs

- holders can invest in a full range of securities & makes all investment decisions

Past Service Pension Adjustment (PSPA)

- in the event an employer upgrades or makes changes to the employees pension plan & employee can contribute more, difference between old PA & new plan PA = PSPA. - reduces the amount an employee can contribute to an RRSP

Capital property income

- includes income from assets purchased solely for investment purposes (stocks, bonds & mutual funds)

Disadvantages of RRSPs

- income tax paid upon withdrawal - no dividend tax credit - upon death, funds are subject to tax as income of deceased, unless transferred to spouse - cannot be used as collateral for a loan

Charges NOT deducted from investment income

- interest paid on funds borrowed to buy investments that generate capital gains only - brokerage fees or commissions to buy/sell securities (affect ACB instead) - interest on funds borrowed for a RRSP, RESP, RDSP or TFSA - admin fee for RRSP - financial planning fees

Acceptable carrying charge deductions relating to investment income;

- interest paid on funds borrowed to earn interest income - fees for certain investment advice - fees paid for management, admin or safe custody of investments - accounting fees to report investment income

Single Vendor RRSPs

- investments in GICs, Seg funds or MFs, held in trust under plan by a particular issuer, bank, insurance company etc.

Income Splitting

- transferring income from a high income earner to a spouse, child, or parent in a lower tax bracket. (e.g. SPL RRSP, family trusts, partnerships, small business corps & investment holding companies).

Attribution Rules

- transferring income to a family member may trigger attribution rules, meaning the tax consequences are passed back to the original taxpayer. - attribution rules for income & capital gains do NOT apply if a married couple is living apart - attribution rules do NOT apply when money is loaned & interest is charged at a rate prescribed by CRA & paid within 30 days after year end.

Registered Pension Plans (RPPs)

- trust, registered with CRA, established by a company to provide pension benefits for employees upon retirement - employer & employee contribution are both tax-deductible - contribution level = 18% of earned income

Registered Education Savings Plans (RESP) (contribution rules, withdrawal rules & taxation)

- withdrawals that were not original capital are taxed in hand of beneficiary who is not in school - no annual maximum contribution - lifetime max = $50,000 per beneficiary - contribution can be made for 31 years - plan must be collapsed withing 35 years of starting date - contributor can withdraw income from RESP if plan has been in existance for > 10 years & none of beneficiaries have attended a qualifying education program by 21, or all beneficiaries have died - if contributor withdrawals money from the plan, the plan must be terminated by February of the next year.

Disposition of Debt Securities (for taxation purposes)

= bonds, debentures, bills, notes, mortgages - accrued interest at time of sale is not included in capital gain - interest income received at time of sale = income on tax return.

Adjusted Cost Base (ACB)

= purchase price + commission expense average cost method used when a number of shares are bought at different prices

For the purpose of RRSP contributions; earned income =

= total employment income + net rental income + net self-employment income + disability pay from CPP/WPP + supplemenary EI benefits ..

Who collects provincial income taxes?

The federal government (for all provinces except Alberta Corporations & Quebec)

Retiring Allowances

long service upon retirement --> added contributions under specific guidelines

Deferred Annuities

payment starts at date specified in contract. Available only through life insurance companies

ACB of convertible securities =

that or original convertible security. Shares not disposed of when converted

Tax Loss Selling

when a tax loss looks beneficial, without breaching investment principles, the taxpayer should consider the timing of repurchase (to avoid a superficial loss) & the settlement date to ensure tax loss reported in desired accounting year.