Taxation – Canada’s 3rd official language!
Putting money aside for your future goals is hard enough without the prospect for additional tax burden. For many investors, taxes represent the biggest impediment to wealth accumulation; whether related to employment income or affecting the efficiency of investment returns.
Principals of Tax Planning
The purpose of Tax Planning is to shift taxable incomes from higher to lower tax rates through the claiming of deductions, optimizing deferral strategies, taking full advantage of available income-splitting techniques and by selecting tax-efficient investment alternatives. While tax avoidance and deferral is encouraged by Canada Revenue Agency (CRA) evasion of taxes otherwise payable by way of omitting revenue, fraudulently claiming deductions and/or failing to disclose all of the related facts is prohibited.
Tax Deductions:
Deductions (write-offs) are a direct claim against taxable income and result in a reduction in taxes payable. Common tax deductions include:
- Contributions made to RRSPs and Pension Plans
- Eligible professional fees including fees levied to certain fee-based investment accounts
- Interest expense on moneys borrowed and reinvested to earn investment incom
- Eligible family maintenance support payments
- Employment expenses
- Union and professional dues
- Eligible child care expenses
- Eligible moving expenses
- Safety deposit box fees
Deferral benefits:
RRSPs, exempt life insurance and Tax Free Savings Accounts (TFSAs) are all based upon the premise that it is always better to defer your tax obligations into the future rather than pay them today. The concept of time-value reinforces the notion that future dollars are likely to be depreciated by inflation as measured by the Consumer Price Index (CPI;) thus it is beneficial to defer payment of fixed tax obligations as long as possible and pay them with then depreciated dollars.
Moreover, deferral allows you to retain the benefit of access to your money (longer) – should you choose to invest, you may earn additional returns. Within an exempt or tax-deferred environment, returns will compound more quickly than those invested in a taxable account.
Income-Splitting:
Canada’s progressive tax system allows for numerous income-splitting and resultant tax avoidance opportunities, though income attribution rules must be observed. There are numerous strategies which promote income-splitting and tax avoidance as below:
- Contribute to a spousal RRSP
- Split employer pension benefits upon retirement
- Backstop single-life pension options with life insurance; whereby the tax-exempt death benefit may be invested in support of survivor income within a more tax-efficient prescribed life annuity contract
- Split CPP benefits (after 65)
- Contribute to an RESP (for the Canada Education Savings Grant and to pass tax obligations on to children)
- Invest for capital growth within In-Trust-For accounts for minor children
- Invest non-registered savings in the lower income family members
- Invest the child tax benefit in your child’s name
- Spousal transfers at Adjusted Cost Base (ACB)
- Consider spousal loans to transfer 2nd payer income to a lower income spouse
- Where applicable, pay wages to family members (and have your spouse contribute net earnings to a TFSA)
- Structure your business interest to involve family members
- Structure your partnership or incorporate to earn business income and potentially benefit from the eligible Small Business Exemption (SBE)
- Gift assets early and/or consider Inter-vivos (formed in life) or Testamentary Trusts
- Consider an Estate Freeze
Tax-efficient Investment Solutions:
Generally investment income can be broken-out into several categories including: interest income, dividends, capital gains and Return of Capital (ROC.) The table below highlights the tax inclusion rates of various sources of income. A sound investment principle is to focus non-registered savings on more tax-efficient investment solutions while isolating less efficient solutions within the RRSP and/or Tax Free Savings Accounts.
| Type of Income Earned | Assumed Pre-tax Earned Income |
Estimated Tax Inclusion
Rate |
Estimated After-tax Income* |
|---|---|---|---|
| Salary, Interest & other Income | $10,000 |
100% |
$6,000 |
| Eligible Dividend Income | $10,000 |
~68% |
$7,300 |
| Realized Capital Gains | $10,000 |
50% |
$8,000 |
| Return of Capital (ROC) | $10,000 |
50% |
$8,000 |
| Prescribed Life Annuity Income | $10,000 |
20%-30% |
$9,200 |
| Variable Life Annuity Income | $10,000 |
10%-30% |
$9,900 |
CI, Disability & Insurance Death Benefits |
$10,000 |
Exempt |
$10,000 |
| Capital Gains on Principal Residence | $10,000 |
Exempt |
$10,000 |
Though we acknowledge that investment decisions should never be based solely on related tax consequences, we find Tax Planning to be an essential component of the overall Wealth Planning process; especially as you transition from your working career into retirement and beyond.
