Suppose you have a business and CRA (formerly Revenue Canada) conducts an audit. Suppose the auditor spends a week going through all your accounting records; the same accounting records you have honestly and accurately maintained for the past number of years. Suppose this auditor finds things that aren't to his or her liking. Suppose the auditor is very vague with his explanations. Suppose a month later CRA issues you an unexpected "Notice of Reassessment" indicating an additional amount of income tax owing based on the recent audit. You call for an explanation and get an unsatisfactory answer. What do you do? What can you do? What are your rights? First thing you should realize is that the Notice of Reassessment provides a brief explanation indicating what has been disallowed. It is your right to file a Notice of Objection, which gives you the opportunity to provide "your side of the story" with respect to the items that are being disallowed. This Notice of Objection must be filed within 90 days from the date indicated on the Notice of Reassessment. But, before you file the Notice of Objection, wouldn't it be nice to be able to see the auditor's notes as well as any correspondence within CRA about your file. Well, you can; under the Access to Information Act. Making an Access to Information request is relatively simple and inexpensive, and it can open access to a variety of documents contained in the CRA audit file. The types of documents that can be exposed include case summaries, auditor notes and calculations, penalty recommendation reports, supervisor review notes and the rationale for some or all of the assessment. Needless to say the knowledge that can be gained from such disclosure can assist you in preparing a Notice of Objection. To make an Access to Information request you simply attach your request to a completed application form and mail them, along with the $5 processing fee, to the CRA information co-ordinator in Ottawa. In 30 to 60 days, after paying an additional photocopying fee, you will receive your package of documents.
There are both tax and non-tax reasons for considering incorporating your business and/or investment affairs. The two most significant "tax" benefits of incorporating a Canadian business are:
a tax deferral is possible by retaining earnings in the corporation and the $500,000 capital gains exemption available for the sale of shares of a small business corporation (this exemption is unavailable for unincorporated businesses)
With respect to tax deferrals, be advised that net income of a sole proprietorship or a partnership is taxed directly in the hands of the owner. However, a corporation is a separate taxpayer with its own tax rates. A corporation which is incorporated in Canada and is controlled by private corporations or individuals who are Canadian residents will normally qualify as a "Canadian controlled private corporation". This status allows it to claim the small business deduction, a reduction of the normal corporate income tax rate on the first $200,000 of a corporation's annual taxable income earned from carrying on an active business in Canada (recent budgets have increased the $200,000 level). The tax advantage which the shareholder will enjoy is the ability to defer the payment of some income tax. A corporation eligible for the small business deduction pays tax at about 23 percent on its first $200,000 of taxable income. The remaining tax, which is paid by the shareholders upon receipt of dividends from the corporation, is deferred until the dividends are actually paid out. The deferral is significant, especially for a taxpayer in the top tax bracket and means that approximately twice the funds are available for investment. The other main tax advantage to incorporation is the ability to claim the $500,000 capital gains exemption on the sale of a business. The complex rules provide that, to claim the exemption, the shares must be of a Canadian-controlled private corporation, at least 90 percent of the assets of which are used in an active business carried on in Canada, or a holding company which owns such shares. Where the shares qualify, the owner can sell them and the first $500,000 of capital gains are exempt of tax. Note that the exemption applies to the individual and not the corporation. Another significant advantage to incorporating is the limited liability for the owner. Although this is a "non-tax" advantage it is still a very significant advantage. While a sole proprietor or partner in a general partnership has unlimited liability to creditors of the business, shareholders of a corporation have no such risk. Without the protection of limited liability most entrepreneurs would not take the risk of going into business.
Due to the nature of certain mutual funds buy and hold investment philosophy, unrealized capital gains often accumulate within portfolios as the unit prices rise over time. Those of us in the investment business sometime express concern that, if a fund must sell securities to meet redemptions, remaining unitholders could be faced with capital gains distributions at the end of the year. Investment companies deal with this concern in two ways. Firstly, to meet reasonable levels of redemptions, companies maintain adequate short-term investments in each fund. Secondly, if securities must be sold to meet redemptions, companies make use of the "capital gains refund mechanism (CGRM)" to deal with the capital gains triggered by that sale. The CGRM allows the fund to realize those gains without having to pay taxes on all or a portion of the gains (as determined by a detailed formula which takes into account units redeemed during the calendar year). The purpose of the CGRM is to shelter the portion of the capital gains realized by the fund that approximates the gains realized by redeeming investors during the year. Without the CGRM, the same underlying capital gains would be taxed twice; once in the hands of the redeeming investor and again in the hands of the remaining unitholders. As a simplified example, let's say a mutual fund has only two clients. Each of Client A and Client B invested $5,000. Now, two years later, the fund's portfolio has doubled in value to $20,000 and Client A and Client B have investments worth $10,000 each. Client A redeems all of his units for proceeds of $10,000 (his initial $5,000 investment and $5,000 of capital gains), realizes the $5,000 capital gain and reports this as income on his tax return. The fund had to sell securities to pay the $10,000 of redemption proceeds to Client A. That sale by the fund would also trigger a $5,000 capital gain within the fund. However, because Client A has already received and will be taxed on the $5,000 gain, the fund is not required to distribute or pay tax on the same gain. This is good news for Client B since, without the CGRM, he would get a T3 indicating his portion of the capital gain within the fund. The CGRM significantly allocates the impact of capital gains to the appropriate investors. Even if the investment company has sufficient cash on hand to meet redemptions, it still may be advantageous to realize some capital gains. This process is called "crystallization" whereby the fund sells securities, triggering a capital gain, and then immediately repurchases those securities at the current higher price. The CGRM can only be used to offset redemptions against gains in the same year, so crystallization is used towards the fiscal year end to create the gains that approximately match annual redemptions. In this way the fund will not have to declare the gain. Additionally, the crystallization increases the book value of the securities and reduces future capital gains liability.
Revenue Canada's latest attempt to unearth the underground economy has hit the construction industry hard. In its last budget, the federal government announced the "Contract Payment Reporting System"; a system that will require construction companies to report to Revenue Canada all payments made to subcontractors if their "primary activity is construction" (defined as having more than 50 percent of your income derived from construction). The effective start date for the Contract Payment Reporting System is January 1, 1999. Businesses must ensure that their record-keeping systems capture the necessary information to file their first information returns on or before March 31, 2000. Construction companies will be required to remit the names and addresses of their subcontractors, their business numbers if they are registered as a business or their social insurance number if they are not registered as a business. Administratively, Revenue Canada will not require an information slip if the subcontractor was paid less than $500 in total for the reporting period. So who do those new rules apply too? Revenue Canada defines the construction industry to include any individual or business which erects, excavates, installs, alters, modifies, repairs, improves, demolishes, dismantles or removes all or any part of a structure, surface or subsurface of any property or building. In other words, this will apply to everyone in the building, renovation and construction business. Initial government proposals suggested that, in addition to reporting their subcontractors to Revenue Canada, construction companies might also be forced to send their subcontractors annual statements of earnings. Revenue Canada decided not to demand this of construction companies in order to limit the burden on them. Similarly, the government decided the reports may be filed for either fiscal or calendar years. This was a great relief to the construction industry since year-ends vary among construction companies. It should also be mentioned that The Income Tax Act now gives the industry the authority to ask for a business number or a social insurance number for purposes of the Contract Payment Reporting System. You must make a reasonable effort to get the required information for Revenue Canada. Every subcontractor or individual is required to provide this information, and if they fail to do so, the responsibility shifts to them and they will be penalized. One last thing, for all the people in the construction business who chose to visit their accountants once every 3, 4 or even 5 years, I would seriously consider changing this habit and try visiting us every year before the income tax filing deadlines. Revenue Canada will be imposing very serious penalties for late filing as well as non-compliance of the Contract Payment Reporting System and they have some very interesting ways of collecting these penalties. Do yourself a favour, avoid getting penalized. All of you in the construction business have been warned.
Hey parents, do you have kids going to post secondary school? If so here is a quick summary of the "tax issues" you need to know. If your child received a scholarship, fellowship, bursary or a prize (a prize would be a payment for achievement in a field of endeavor) then only the amount over $3,000 is subject to income tax. These types of payments are accounted for on an accumulated basis for each calendar year. Not eligible for the $3,000 exemption are training allowances under the "National Training Act" or payments from your RESP. Speaking of RESPs, I must admit that I finally like these plans (I did not like them before Revenue Canada made some recent changes to RESP legislation). You now get a Canada Education Savings Grant (CESG) of 20% on the first $2,000 in annual contributions up to age 18. Unless I'm missing something you just got a 20% rate of return on your $2,000! Not only do I like that, you no longer have restrictions as to which child uses your RESP. You can now set up "Family RESPs" which allows you tax-free growth in one plan which can be used for all your kids. Those are the 2 main reasons why I now like RESPs. Revenue Canada also allows you to catch-up for last years 20% credit. By this I mean that if you did not contribute $2,000 last year to an RESP, you can do it this year along with your current RESP contribution therefore you are putting $4,000 per child and getting a 20% grant which would equal $800; not bad! Another common component of post-secondary education is "research grants". Simply put, a research grant is a grant given to a student to undertake specific research. A research grant is taxable net of expenses incurred to carry on their work (the $3,000 exemption mentioned above does not apply to a research grant). Another thing to remember is moving expenses. These costs are deductible from a student's net income. Be aware that the move must bring the student 40 kilometres closer to the educational institution from their primary residence. Next point; loans. The "grant" portion of a student loan is taxable as a scholarship, fellowship or bursary, net of the $3,000 exemption. Student loan interest can now be deductible as "educational tax credits" along with the actual tuition costs. Speaking of educational tax credits they too have been recently enhanced. You now get a $200 monthly credit for each month of full-time attendance (as well as certain part-time educational courses). With all these tax benefits available why are we complaining so much about post-secondary education costs? Could it be the $30,000 to $50,000 it costs us to give our child an education? I think so. At least Revenue Canada helps us in a small way (a very small way)!
Canada taxes its residents on their worldwide income. This simple rule also requires Canadian residents to declare their income no matter where they earn it. Since the tax system depends upon voluntary compliance, it works well only if all foreign income is disclosed. The disclosure of foreign source income is an increasingly difficult problem for Revenue Canada. First, as Canadian tax rates escalate, taxpayers find it increasingly attractive to settle their capital in tax havens and offshore investments. Second, Canada encourages immigration of wealthy families through the Immigration Investor Program. This program brought a large number of wealthy individuals to Canada, particularly from Hong Kong. A lot of these new Canadians did not, however, always bring all their assets into Canada. Accordingly, in 1995, in an effort to increase tax compliance, Revenue Canada issued draft information rules setting out new stringent reporting requirements. One of these rules would have required individuals with more than $100,000 in foreign property to disclose details of these holdings (property for personal use was excluded from disclosure). The clear purposes of these rules was to provide Revenue Canada with an audit trail that they could pursue in their quest for undisclosed foreign income. The new reporting requirements was severely criticized as an unwarranted intrusion into the personal lives of Canadian taxpayers. New immigrants threatened to leave the country and take their assets with them if they were forced to disclose them. Fortunately Revenue Canada backed off its original requirement of detailed disclosure. Instead, on August 20, 1998 Revenue Canada announced that it would introduce a new "check-the-box" format for foreign asset reporting. The new requirements, starting with your 1998 tax returns, are superficially less onerous. Taxpayers will be asked to check a box on their tax returns to indicate the type of property, the location of the property and the range of investment levels. As always, they will be required to report any income from the property. Although the new rules do not require detailed disclosure of information, they do require enough disclosure for Revenue Canada to pursue through follow-up audit procedures. In a sense I think the new rules are really more cumbersome than the old rules because individuals will be contacted by Revenue Canada in follow-up audits and asked to provide further and better particulars of their foreign assets. This will take time, involve costs for legal and accounting fees, and intrude into taxpayer privacy just as much as the original proposals. In the end, I believe the new reporting rules will cost more both for taxpayers and Revenue Canada.
You've started your own business, things are going great. Now what ? You should probably consider incorporating your business. In legal and financial terms, you are creating a separate legal entity. The company's assets, loans and income become distinct from those of the owners. There are three main reasons why you may consider incorporating your business; 1 (limiting your personal liability 2) numerous tax advantages 3) the ability to raise capital because investors can purchase shares of your company without putting their personal assets at risk. Be advised that a corporation must be properly organized before it can carry on business. There are shares to issue, directors to elect, officers to appoint, resolutions to prepare and by-laws to create. Shareholders, who are typically family members in a small business corporation, are entitled to vote (assuming their shares are voting as opposed to non-voting) and receive dividends. Voting shareholders are responsible for electing company directors, who in turn are responsible for the overall management of the business. The directors then appoint the company officers (namely to the top positions such as president and treasurer). The directors also have to appoint the company's accountant and designate a fiscal year end no later than 53 weeks from the date of incorporation. You can incorporate federally or provincially. Federal incorporations allow business activities as well as physical locations throughout the country. Provincial incorporations allow business activities as well as physical locations within Ontario (be advised that a provincial incorporation allows you to conduct business throughout Canada, however you can only have physical locations within Ontario). Federal and Ontario corporations have to publicly disclose they're registered office addresses, as well as the names and addresses of their directors. Ontario companies also have to disclose officers' names. The provincial government must also be notified of any changes. The biggest challenge facing someone who incorporates their business can be getting used to the new rules and regulations. For example, the owner of an unincorporated business may be accustomed to withdrawing money from their business bank account as they see fit. This is okay because these withdrawals are non-taxable. These types of withdrawals are not so simple with a corporation. The cash in the bank account belongs to the corporation and must be accountable to Revenue Canada if withdrawn. These withdrawals can be accounted for as dividends, wages, bonuses or as a repayment of money previously contributed by shareholders. Once you have decided to incorporate you business the first order of business would be to select a name and clear it with the Ontario Ministry of Consumer and Commercial Relations. You can either use your actual business name with the words "Limited", "Incorporated" or "Corporation" attached to the end or, as an alternative, you can incorporate a "numbered" company and set up your business name as a division of the number company (ie. Sam's Hockey School / a division of 1234567 Ontario Limited). Regardless of how your company is structured you are required to do a "name search" for the company name to ensure that name is not already being used. Once this process is completed you must prepare articles of incorporation. Once the articles are complete they must be signed and filed with the appropriate government authority. The actual filing process consists of someone going to the ministry and delivering the signed articles of incorporation along with the name search report. Assuming everything is in order, they get a stamp on them and you're incorporated.
Much to my surprise I have found that not many people are aware of the federal government's "lifetime learning plan" (LLP). This plan, which was introduced in 1998, allows you or your spouse to withdraw funds from your RRSP on a tax-free basis and use the funds to pay for tuition fees and other educational related expenses. The tax-free withdrawal is allowed for full-time programs (at least ten hours per week is considered full-time) that is at least three consecutive months in duration. The maximum amount that can be withdrawn in any one year is $10,000. Withdrawals are allowed for up to four years, and the total that can be withdrawn over the four years is $20,000.Under the LLP, both you and your spouse can withdraw from your RRSPs at the same time. Each of you is separately subject to the $10,000/$20,000 limits, meaning that these limits can be "doubled up". You can each use your withdrawal for yourselves, you can each use your withdrawal for the other spouse, or you can use both of the withdrawals for only one of you. However, be aware that each one of you can withdraw funds for only one student at a time. For example, you cannot withdraw amounts for your spouse if you have already withdrawn funds from your RRSP for your own studies. An amount can normally be withdrawn under the LLP only if the student is enrolled on a full-time basis at the time of the withdrawal. However, an amount can be withdrawn before the actual enrolment if the student has received written notification that he or she has been admitted to enroll on a full-time basis before March of the following year. If, for some reason, the student does not actually enroll, the withdrawn amount must be repaid to the RRSP by the end of the year following the year of withdrawal. Assuming that the student does enroll, the amounts withdrawn under the LLP must be repaid to the RRSP over a period not exceeding ten years. The repayment period starts with the earlier of the second calendar year after the last year of full-time enrolment or the fifth calendar year after the first year in which a withdrawal was made. The repayments made to the RRSP are not tax deductible. The LLP is becoming widely recognized as an alternative to conventional saving methods for your education needs.
If you are saving for your first home, you might consider using your RRSP as a savings vehicle. Although RRSPs are intended primarily for retirement savings, qualified first-time homebuyers are permitted to withdraw up to $20,000 from their RRSPs to help buy or build a principal residence. As an added bonus, if your spouse also has an RRSP and there will be joint ownership in the property, he or she is entitled to withdraw up to $20,000 from their plan. Thus, if both of you take out the maximum allowed, a healthy down payment of $40,000 can be made on your first home. Normally withdrawals from an RRSP are taxed in the year withdrawn, but with the Home Buyers' Plan, the money is loaned tax-free from the RRSP with the proceeds to be paid back over a 15-year period. You must use form T1036 Applying to Withdraw an Amount Under the Home Buyers' Plan for the amount to be considered non-taxable when you withdraw it. Repayments begin in the second year following the withdrawal and the minimum repayment is 1/15th of the amount borrowed. What happens if you do not make the required repayment to your RRSP in a certain year? In such a case, the amount you were required to repay would be considered taxable in that year. The outstanding balance to be repaid to your RRSP is reduced each year by the yearly repayment amount regardless of whether you make the payment or not. For example, if you took $15,000 from your RRSP and put it towards a down payment on a new home, your yearly repayment would be 1/15th of the amount withdrawn, or $1,000. If, in the first year you are required to make a repayment, you fail to do so, it will be included as income on your personal income tax return for that year. If your tax rate is, say, 40 percent, you will be paying $400 in additional taxes because you did not make the repayment. The remaining balance to be repaid to your RRSP is still reduced from $15,000 to $14,000. In the second year, again you must repay $1,000, and if not, it is included on your tax return as taxable income, and so on. Many specific conditions apply for an RRSP withdrawal to qualify under the Home Buyers' Plan, therefore professional advice should be solicited to make sure everything is done according to the proper guidelines. This will prevent Revenue Canada from deeming the amounts withdrawn as taxable, which would cause a major tax headache in that particular year.
If you are a small business owner, there is a tax savings opportunity available that you may not be aware of. If a portion of your business is regularly conducted out of your home a percentage of your ongoing home expenses can be claimed as business expenses.
The percentage that you are able to deduct is based on the fraction of the home that is used for your office. For example, 'Mary' is a computer programmer working as a consultant to various companies. She has an office in her home that measures 150 square feet. The total area of her home is 1500 square feet. Provided Mary meets the requirements set out by Revenue Canada, she will be able to deduct 10 percent of her home expenses against her business income.
The eligible expenses relating to your home office include rent, mortgage interest paid, property taxes, utilities, telephone, home insurance, and repairs and maintenance (i.e. snowplowing and minor repairs). You may also claim depreciation (or capital cost allowance) on the home office, but doing so eliminates the principal residence status of that portion of your home. In other words, you will pay tax on any capital gains realized if the property is sold. For this reason, it is not normally advisable to claim depreciation.
Home office expenses are subject to some restrictions. These expenses can only be used to offset business income. You cannot use home office expenses to create or increase a business loss, which then can be applied against other income. If after deducting all regular business expenses there is a loss, you should still claim all applicable home office expenses because you are allowed to carry forward any unused expenses to future years.
Home office expenses are only allowed if one of the following conditions is met:
your home is your principal place of business, i.e. you do not have an office elsewhere; or the home office is used exclusively for business, and is used " on a regular and continuous basis for meeting clients, customers or patients".
Note that any expenses used exclusively for business purposes are fully deductible. These expenses include a separate business phone line, fax and printer paper, and computer repairs (if the computer is not used for personal purposes also).
As with any regular business expenses you must remember to keep receipts on file to back up your claims in the event of an audit by Revenue Canada.
It is well known that any gain realized on the sale of your home is normally exempt from tax, due to principal residence rules. With some careful planning you can utilize these rules to realize certain tax advantages.
To qualify as a principal residence, the property must be "ordinarily inhabited" by you, your spouse or your child. You should be aware that the term 'principal' residence is not taken literally. A cottage will qualify, for example..
Since 1982, only one principal residence can be designated by the 'family unit', which consists of you, your spouse (including a common-law spouse), and any unmarried children under 18 years of age. The family unit distinction prevents you from designating your house as your principal residence and your spouse designating the cottage as his or her principal residence, effectively eliminating capital gains tax on the sale of both properties. Prior to 1982, each taxpayer was entitled to a principal residence exemption. Thus, where two members of a family unit owned two residences (such as a regular home and a cottage) before 1982, it may be possible to structure their holdings such that the pre-82 gains are exempt from tax.
Those with adult children should consider giving them ownership of a second residence. Any gains must be realized when ownership is transferred, but the child can designate the second residence as his/her principal residence when the property is sold, eliminating any further taxable gains on the property. If you consider this option you should also be aware of the legal implications of the change in ownership - the child would have complete control over the property.
There are certain cases when rented-out property becomes eligible for the exemption. If you move out of a home and begin renting it out, you can continue to designate it as your principal residence for up to four years by filing a special election. Moving for reasons of employment will allow you to extend the four year period indefinitely as long as you move back to the home upon leaving that employment. An exemption is also possible if you acquire a property, begin renting it out, and then move in at a later date. This allows you to defer the capital gain that normally applies when changing from an income-earning property to a personal-use property.
To ensure things are done properly, seek professional advice before attempting any of these strategies.
After 20 years of working in the financial field the question I get asked most often is whether to lease your car or whether to buy your car. Everyone who asks this question, whether self-employed or not, is always looking for a simple one word answer; lease or buy? Unfortunately this is not possible. In fact, a lot of information is needed to properly determine whether it is more advantageous to lease your car or buy your car. The first thing you need to realize is that any tax advantage you may get from buying or leasing your car (ie. if you are self-employed) is NOT taken into consideration. The reason that the potential tax benefit is excluded is due to the fact that over a 3 or 4 or even 5 year period of time, any tax benefit you may possible derive would basically be the same whether you buy the car over this period of time or whether you lease the car over this period of time. Accordingly take any possible tax benefit out of your calculations when considering leasing your car vs. buying your car. So if you don't consider the potential tax benefits, what do you consider? The best thing to do is identify all the pros and cons related to leasing your car vs. buying your car and consider these issues individually. LEASING A CAR - THE PROS; usually leasing a car is very easy on the pocketbook (first and last months lease payment plus applicable taxes and you drive away with a new car); you usually have a good warranty; you usually have the backing of the dealership in case of any problems; usually leasing a car does not negatively effect your debt-equity ratio; some lease have a "walkaway" component to the lease. LEASING A CAR - THE CONS; you don't own the car; restrictions on the amount of kilometers you can drive; you can't sell the car (it's not yours to sell); your car must maintain a regular servicing schedule (usually at the place where you lease the car); you are responsible for any repairs and/or body work that may be required at the end of the lease; it is very hard to get out of a lease once you enter into a leasing arrangement; usually the price isn't negotiable; some leases have a fixed buyout at the end of the lease. BUYING A CAR - THE PROS; you own the car; no restrictions on the amount of kilometers you can drive; you can sell your car anytime you want; you usually have a good warranty; you can usually negotiate a better price if you are buying. BUYING A CAR - THE CONS; you have incurred a significant amount of debt; negatively impacts your debt-equity ratio. After considering the pros and cons related to leasing your car vs. buying your car you must now consider one of the most important issues; what is the interest rate you are paying for your car? You must know the interest rate you will be paying if you are buying your car and you must also know the interest rate "built-in" to the lease if you are leasing your car. Make sure the interest rate is competitive (I have seen people lease cars with built-in lease rates of over 20 percent without them even knowing this). The two biggest things you should NEVER do is pay cash for your car or lease your car where you must buyout the car at the end of the lease. In summary, whenever I get asked the question of whether to buy a car or lease a car, I always tell the client that they must first go out and find the car they want, then they must negotiate the best deal to buy the car as well as negotiate the best deal to lease the car. With this information, as well as giving consideration to the above-mentioned items, it can now be determined which option is best for you. For anyone considering leasing a car or buying a car, I should also mention our new Auto Deduction Program (ADP). Our ADP program allows you to convert the cost of your car into a deduction for income tax purposes (even if you are not self-employed). Please call for further details.
The last thing you want to think about during a golf event is Revenue Canada. Still, the tax treatment of events held at golf courses is something that confuses many financial advisors. Some of this confusion came from a prior Revenue Canada ruling that prevented deduction of meals consumed on a golf course. Subsequently Revenue Canada changed their position. It will no longer deny tax write-offs for business-related costs incurred in the dining rooms, banquet halls, conference rooms and lounges of golf clubs. The tax treatment of the cost of food and drink consumed in golf clubs is now the same for expenses incurred at other establishments. That means that if meals are business-related, they are generally 50 per-cent deductible, and may be 100 percent deductible if they relate to a charity fund raiser or office golf dates. In order to deduct these expenses, Revenue Canada regulations say meals and beverages consumed at the golf course must be clearly itemized and noted on the receipt that it is business related. It should also be noted that membership fees, green fees and other charges for access to recreational facilities at the golf course continue to be non-deductible. This type of tax treatment has been a bone of contention with business people. It is a well-known fact that a lot of business is done on a golf course; why shouldn't the cost relating to these "golf/business meetings" be deductible. Here's a suggestion. If you are an avid golfer and do purchase a membership each year, consider rearranging the way you pay for your membership. Instead of simply paying your membership fee and not incurring a business expense, why not ask the owner of the golf course if you can pay a sum of money for annual advertising at the golf club (this sum of money should be the same amount you would normally pay for a membership). Along with your "advertising commitment" the owner of the course allows you to golf for free each summer. In this way you have made your membership fees tax deductible!
An "estate freeze" is the term used to describe steps taken to fix the value of your estate (or some particular asset) at its present value, so that the future growth will accrue to your children (or a trust for your children) and not be taxed on your death. Estate freezing is most often used when you own a business that you expect will increase in value in future years. Your children may be involved in running the business. Even if they are not, you may want them to own it after your death. An estate freeze can significantly reduce the tax payable on your death, if the value of your business is "frozen" sufficiently early. The lower cost base will effectively be transferred to your children, and so the tax on the subsequent capital gain will be deferred until they sell the business (or until their deaths). You can also multiply the availability of the capital gains exemption for certain small business shares (if it is still available when your children eventually dispose of the shares). At the same time you do not need to give up control of the business. You can also continue to receive income from the corporation, either by declaring dividends or by drawing a salary if you continue to work in the business. If you use a trust to acquire the common shares, you can retain flexibility with respect to allocating the shares of the business among your children later. Whether an estate freeze is useful to you will depend very much on your business, your financial position, your future plans and your goals. There are many different types of estate freezes, the following example is one of the simplest types: EXAMPLE I own all of the common shares of X Corp (my business). My original share investment in X Corp was $100 and it is now worth $400,000. I expect it to increase in value significantly over the next several years. I have two children, Sam and Steven, who work in the business. First, I exchange my common shares of X Corp for 400 new preferred shares. The preferred shares are voting shares. They are also retractable at any time, at my option, for $1,000 per share. In other words, I can demand that X Corp pay me $400,000 for my shares at any time. Sam and Steven each subscribe for 50 new common shares in X Corp paying $1 per share. Over the next few years the value of X Corp rises to $900,000. Now my preferred shares are still worth only $400,000, but the common shares owned by Sam and Steven are worth $500,000. I have thus transferred the post-freeze "growth" in X Corp to Sam and Steven at no tax cost to myself. Note also that since my preferred shares are voting shares, I have kept control of the corporation. I have 400 votes and Sam and Steven together have only 100.
Although you're probably preoccupied with Christmas and New Year's preparations, it would be wise to take a few moments to consider your tax and investment situation before the year draws to a close.
Here are a few year-end tips….
Tax loss selling.
Before the end of the year, you might want to realize any non-RRSP losses incurred thanks to the unfriendly markets this year. If you still like the investment but were just a victim of bad timing, sell it but wait at least 30 days before you repurchase it, otherwise Revenue Canada will disallow the loss. Apply your losses to any realized capital gains incurred either this year, the previous three years, or any future year(s).
Mutual fund distributions.
Delay any non-RRSP mutual fund purchases until after the fund makes its year-end income distribution. Otherwise, you are paying an inflated price for your funds (the price decreases after a distribution) and you will be taxed on gains that you didn't even participate in.
Spousal RRSP contributions.
Make a spousal RRSP purchase in December rather than waiting until January or February . The benefit of this strategy arises if you have to withdraw the money in the near future. Spousal plan withdrawals made in the year of purchase or the two following years are taxed back to the contributor (who is usually in a higher tax bracket) rather than the spouse. For example, a contribution made in 1998 can be withdrawn in 2001 and you avoid this attribution rule. Waiting an extra month or two (contributing in 1999) means that the attribution rule is in effect for another full year - until 2002.
Did you turn 69 this year?
If you did, you have a major financial decision to make before the end of the year. Your RRSP must be converted to a RRIF, an annuity, or cash. Doing nothing results in the cash option which is the least desirable tax-wise. You should also consider making one final RRSP contribution (and possibly even an over contribution) before the end of this year.
High income earners should be aware that December 31 is the deadline to make any tax sheltered investments that will benefit your current tax situation.
Those of you who attended our last investment seminar were very interested in hearing why we question the logic of building up RRSPs throughout our working years. Although we believe everyone should have a certain amount of money in RRSPS, we emphasized the need to limit their usefulness in your complete financial planning process. We take a different approach to financial planning but we believe it is a better approach. We discussed many reasons why we take this approach and here is another example of someone directing their retirement funds (and working energy) towards something other than RRSPs. Many years ago one of our clients put every cent into buying a motel in need of a lot of repairs. They invested a lot of their hard-earned money as well as a lot of sweat equity into this project. At the appropriate time the business was incorporated into a limited company to operate the motel. Children came along and through the limited company they worked for their parents. Significant income-splitting was accomplished and accordingly the couple's incomes were taxed at a much lower rate. The couple never paid much attention to RRSPs. When they had extra money they put it back into the motel. They were convinced that their motel would become their retirement savings plan. Years later the couple sold their motel business by selling the shares in their company. By selling their shares they were able to claim the $500,000 capital gains exemption (which still exists today for the sale of shares of qualifying small businesses). Effectively this couple enjoyed the same tax-free compounding offered inside an RRSP through the growth of the value of their business. Best of all when they took out the money from the "retirement fund", they paid no income tax because of the capital gains exemption. By contrast, when someone withdraws RRSP money it is fully taxable; not only does this increase their "net income", which reduces or eliminates certain payments they would otherwise be entitled to, but it increase their "taxable income" which puts them into a higher marginal tax bracket. Along with many other reasons, this is just another example of successfully putting your money into a non-RRSP investment program.
Demography is described by Oxford as 'the study of the statistics of births, deaths, disease, etc., as illustrating the conditions of life in communities.' An interesting area of study related to demographics commonly called 'boomernomics', looks at the effects of the baby boom of 1947-1965 on our economy.
The result of massive immigration, a strong economy and thousands of lonely war heroes arriving home was the emergence of a generation larger than any the world has seen.
Certain markets and society as a whole have been affected significantly by 'the boomers'. Overcrowding in hospitals and schools bursting at the seams in the late 40s and into the 50s, and interest rates skyrocketing to 22% in the 70s due to the enormous demand for financing as the boomers graduated from university are examples. Arguably the most visible market to feel the power of the baby boom is real estate. The residential housing boom and subsequent bust in the 80's and early 90's can be considered a direct result of the boomers' search for homes. Many were able to become quite wealthy through speculating on real estate investments at that time. Once the boomers had found a place to live, however, the laws of supply and demand took over and investors who held on too long lost big.
So what can events such as the real estate boom and bust teach us? We can determine which markets the boomers will be looking towards in the future and act accordingly. One that we are already noticing is North American stock markets. As the first boomers reach 50 years of age in 1997 we can see them beginning to direct their dollars toward retirement savings vehicles at an accelerating rate. North American stock exchanges continue to march upward despite inflation fears, warnings of 'irrational exuberance', and an Asian currency crisis.
With the boomers shifting their habits from spending to saving, we should see stable, if not decreasing interest rates because the demand for financing is just not there. Thus, interest bearing investment vehicles should produce significantly lower returns relative to equity (stock) investments on average, and North American markets could very well continue their upward climb for the next 12 to 15 years.
We should all look to take advantage of the opportunities and avoid the pitfalls we are confronted with as a result of 'boomernomics'.
Somewhat lost in the publicity over cuts to general income tax rates has been the increase in Canada Pension Plan premiums that came into effect this year. While EI premiums were reduced, the net result is that total payroll taxes will increase this year. Moreover, CPP premiums will increase steadily until 2003, when they will be a whopping 9.9% of insurable earnings. The objective is to ensure that the Canada Pension Plan remains a viable part of our social umbrella, even in the face of a huge bulge in seniors due to maturing baby boomers. Actuaries say the CPP will be on a relatively firm footing, but others aren't so sure. Last year, for example, the C.D. Howe Institute questioned many of the assumptions made in the government's financial model, and implied that the 9.9% contribution rate was too low to sustain future benefits. Alberta has called for a full review and suggested it could opt out of the plan. Paul Martin says the federal government is willing to make further changes to alleviate concerns. There are three basic ways to ensure the viability of CPP: raise premiums, improve ongoing investment returns, and lower the benefits. So far, a schedule for increasing premiums has been announced, and fund assets are being invested more aggressively, in part through equity purchases. The benefit level has not been changed, though this is the route being taken by Americans. Facing the same pressures on its social security plan, the eligibility age is being raised gradually to 67 from 65. Will the CPP still be around in its present form in 20-30 years' time? By the year 2030, some observers calculate that the ratio of productive workers supporting pensioners will be 2:1, down from 7:1 only 50 years ago. That's an unsettling thought for a pay-as-you-go pension plan like the CPP. Prudent investors will look after their own future. If CPP continues to pay, it's a bonus. If not, they will have protected themselves. The moral of this story - be among the prudent and build your own source of independent retirement income.
You may notice increasing references to the new currency that is being adopted by many European countries. The euro went into effect in January, although bills and coins will not appear until 2002. Eleven countries have already committed to the new currency, including Germany and France. Exceptions at the moment include Greece, Denmark, and Sweden. Eventually, florins, marks, francs, escudos and other currencies will disappear from use, with the euro becoming the sole legal currency of participating countries on January 1, 2002. The euro is important to us because it is a super-currency, in the same league as the US dollar. The European Monetary Union brings together 290 million people and 20% of the world's GDP. It is a formidable trading bloc - about one-third larger than the US in terms of consumers. Countries adopting the euro will benefit from closer economic coordination, liberalized trade and perhaps more uniform taxes. The European Central Bank will exert discipline, for example, to keep inflation in check throughout the union. Tourists will welcome the new currency as they can avoid expensive and confusing currency exchanges as they move from country to country. It makes international business much more efficient as well, for much the same reasons but on a larger scale. A new currency does not preclude fluctuations in value. Over the first half of 1999, the value of the euro fell sharply relative to the Canadian dollar as a result of a slow-down in European economies. This has, of course, temporarily affected the values of some international investment funds. Over the long term, however, the euro is another indication of the resurgence of Europe, and the need for continued portfolio representation in the region.
US Federal Reserve Board Chairman, Alan Greenspan, has hinted recently that an interest rate hike may be needed to combat the looming possibility of inflation. Any time Mr Greenspan comments on interest rates, you can be sure that market watchers are taking note.
In the short term, stock markets tend to move inversely with the direction ( or anticipated direction ) of interest rates. If rates are expected to increase, the market may trend downward. The opposite is likely to happen should there be the potential for a rate decrease.
Why does the market react this way to interest rate changes? There are a couple of reasons.
Lets assume interest rates have been lowered. Investors preferring interest bearing investments such as bonds or GICs are not happy because the returns they can achieve on their money will shrink. As a result, some may consider taking on a bit more risk with stocks and equity mutual funds for the potential to realize greater returns over the long term. Generally, a lower interest rate environment fuels investor demand for stocks and as a result, the market may get a boost.
Continuing with the same example of decreasing rates, business owners, corporate management, consumers and investors alike realize that lower rates create a healthy environment for doing business. Consumer spending generally increases when rates move lower as corporations discover that it's cheaper to finance major expansion projects. You might even find it worthwhile to take on a mortgage or car loan at these new lower rates. Naturally, when more goods are being purchased, the companies producing these goods become more profitable making their stock attractive to investors. Again, demand for stocks increases and stock prices rise accordingly.
This is not to encourage investors to attempt to 'time the market' by predicting when interest rates will change. More often than not, this strategy is a losing battle. There are many factors at work affecting the ups and downs of the market so this inverse relationship may not always take place as expected. So please do not sell your entire investment portfolio because you think interest rates are on the rise! In a case where the market has dropped due to a rate hike, however, investors may be presented with an attractive buying opportunity.
A Pre-Authorized Chequing Plan, or PAC, is the first option to be considered. A PAC is simply investing a set amount of money at regular intervals. Say you choose to commit $300 each month to long term investing. Assuming you can earn a return of 10 percent over a twenty year time period, you will have invested $72,000 and your investment will grow to about $227,800.
As another option, you may choose to commit that same $300 each month to a leverage program, also know as borrowing to invest. In most cases, using this strategy allows you to deduct the interest you pay on your loan. A $300 per month leverage program (actually $304 15) translates into a $40,000 20-year loan with a 6.75% interest rate. Earning a 10 percent return per year, your $40,000 investment will grow to approximately $270,000. Assuming the investment does not distribute any income and a 40 percent marginal tax bracket, you will have paid $72,995 to service the loan while saving about $13,200 from the tax-deductible interest for a net out-of-pocket cost to you of $59,795.
In summary, over 20 years, your PAC plan will cost you $72,000 out-of-pocket and generate a portfolio of $227,800. The leverage program will cost you $59,795 out-of-pocket and generate a portfolio of $270,000. As you can see, the leverage program in this example costs $12,205 less and grows to a value more than $40,000 greater than the PAC plan.
Be sure to note that you are subject to greater risk with a leverage plan than a PAC since you have the responsibility to service your loan and fluctuations in your investment can magnify any declines as well as increases. PACs can offer much more flexibility in that you can change or cancel your monthly commitment at any time. Consider more than just the final numbers before using any investment strategy.
What to do with your investment cash flow is a major decision. Due to the complexities involved, consult with a professional advisor before choosing what strategies are best for you.
After years of preparing the framework of the Seniors Benefit program to replace the Old Age Security (OAS) program, the government has recently scrapped this plan. The OAS is back as one of the social programs provided by our government for senior citizen. This is probably a good time for a refresher of the OAS program as it now applies. First thing you need to know is OAS is payable at age 65 and an individual can qualify under the "old" rules or under the "new" rules. The old rules can be summarized as follows; any person born before July 2, 1952 and resident in Canada prior to July 1, 1977 who was resident in Canada for at least 10 years immediately prior to the date of application for pension will qualify. The new rules can be summarized as follows; any person who has lived in Canada, after age 18, for periods that total at least 40 years will qualify. It should be noted that, under the new rules, an individual who does not qualify for a full pension may apply for a partial pension if he or she has lived in Canada for a minimum of 10 years after age 18. For each year of residence a credit of 1/40th of the full pension is earned. A person who has lived in one or more countries with which Canada has reciprocal social security agreements may count the periods of residence therein to satisfy the minimum residence requirements. Canada has agreements with more than 27 countries (details may be obtained from any OAS office). In addition to the OAS pension, a Guaranteed Income Supplement (GIS) is available on the basis of need, as determined by income. In the case of a married applicant the income of both spouses are taken into account. The amount is determined by one of two rates. One rate applies to a single pensioner and to a married pensioner whose spouse is receiving either the OAS or the Spouse's Allowance (an allowance available to a pensioner's legal or common-law spouse or to a widowed spouse). The other rate applies to a legally married or common-law couple where each spouse is a pensioner or one of them is a pensioner and the other is receiving the Spouse's Allowance. If a pensioner is receiving only a partial OAS pension (due to insufficient residence) the GIS is increased to close the gap between the full pension and the partial pension. OAS benefits are indexed quarterly in relation to increases as reflected in the Consumers Price Index. With the exception of the GIS and Spouse's Allowance , OAS benefits are considered taxable income under the Canadian Income Tax Act. Moreover, the OAS pension is reduced for higher-income pensioners at the rate of 15 percent of net income over a specified rate amount ($53,215 for 1997). If the full amount of OAS is received, it will be "clawed back" on the same basis; the repaid portion is deductible in determining the amount of income subject to personal income tax. Finally, application must be made for OAS benefits. Up to one year's retroactive payment will be allowed to a person entitled and who files a late application.
Have you ever heard our federal government talk about our national "debt", or our "deficit". Do you realize these terms relate to the same item but they mean different things. Our national debt relates to the total amount of money that Canada owes, presently about 600 billion dollars. Our deficit relates to our annual federal budget. In other words if our deficit is 6 billion dollars, which means the federal government is spending 6 billion dollars more in that particular year than they are taking in (by way of taxes and other revenues). If there is an annual deficit, the government finances these shortfalls by borrowing more money (which would unfortunately increase our total debt). The good news is that our federal government has achieved "balanced budgets" (what they spend equals what they take in each year; ie no annual deficit). This is good because it doesn't further increase our 600 billion dollar indebtedness. In fact, the federal government is actually achieving annual "surpluses" (they spend less than they take in each year). These surpluses have actually been used to pay down our 600 billion dollar debt. Although this is a very positive trend, every Canadian must wonder not only how our government can be 600 billion dollars in debt, but who do we owe this money to. Who lent all the money that financed Ottawa's borrowing binge in the 1990s. You might think the bulk of it came from foreigners, simply because we have heard so much about how responsible we were to foreign lenders to finance our mounting annual deficits. Certainly a lot of the money came from outside Canada. The threat that foreign investors might demand punitive interest rates to keep buying Canadian bonds had a lot to do with stiffening the federal government's resolve to eliminate its annual deficit. But Ottawa's reliance on foreigners to buy its bonds actually dwindled in the 1990s. Most of the cash Ottawa borrowed came from Canadians, some of it from rather surprising sources - such as Canada's banks, which until 1996 used a growing share of their depositor's money to finance large chunks of those annual government shortfalls. Most of Ottawa's public borrowing comes from selling treasury bills, Canada Savings Bonds (which can't be traded) and marketable bonds (which can be traded). Who bought all these treasury bills and bonds ? Let's start with foreigners. Last year, of all the federal bonds outstanding, foreigners held approximately 25 percent. Certainly there were periods when foreigners were major buyers of federal bonds however, they sold some of their holdings in 1995, 1996 and 1997 leaving them with their current holding of approximately 25 percent of all outstanding bond issues. This selloff by foreigners over the last few years forced Ottawa to turn to Canadians. As a result another 50 percent of our national debt is owed to individual Canadians, pension funds, mutual funds and banks. The remaining 25 percent of our national debt is in the hands of Canadian life insurers, other financial institutions, provincial governments, non-financial institutions and finally, the Bank of Canada. Two decades ago the Bank of Canada held about one-fifth of all federal bonds. But as the string of annual federal deficits kept pushing Ottawa's accumulated debt higher, the Bank of Canada chose not to maintain its share. It could have done so, but only by printing more money to buy them, and it couldn't do that without fueling inflation. By 1995, less than 2 percent of Ottawa's bonds were in the hands of the Bank of Canada. Today the Bank of Canada holds about 4 percent of Ottawa's outstanding bond issues.
Have you every gone to Las Vegas and won lots of money. If you have, chances are there will be some missing; probably up to 30 percent. Canadians who win gambling money in the United States are (with some exceptions) subject to a 30 percent withholding tax. Updated rules now permit losses to be deducted from gains, so that it is only the "net" gains that are taxable. Since the full 30 percent withholding is taken at source, a form (1040NR) must be filed with the US Internal Revenue Service (IRS) for any part of the tax to be returned to the individual (be advised that no refunds are payable on tax withheld before 1996). Record keeping is a must. Documents need not be submitted with a claim, but should be made available if the IRS asks for them. Keeping a diary of wins and losses is suggested, noting time, place and game. For slot machines maintain a record of all winnings by date and time that the machine was played, cost of tickets and payment records. For keno, retain copies of tickets purchased and validated by the house, records of casino credit and cheque cashing. On horse, harness and dog racing, hold on to tickets with amounts of winners and losers, unredeemed tickets and payment records. Interestingly enough, the following games are not taxable; blackjack, baccarat, craps, roulette and the big-6 wheel. If by some misadventure tax is withheld on these games, it's recoverable (but no losses are claimable against income earned from these types of games). Sounds like a lot of work just to go to Las Vegas and lose some money. Most people could not be bothered with all the above-mentioned record keeping and I can hardly blame them. However, if you do get a big win and are missing 30 percent, remember what I told you.
When leaving your place of employment, whether it's due to dismissal or retirement, you may be entitled to receive a sum of money from your former employer. If you've worked there for a number of years this amount can be quite large. What you choose to do with the money can have serious financial implications.
Most employers will allow you to receive your entitlement through periodic payments (i.e. monthly) or as a lump sum. Either way you must claim the amounts you receive as income on your tax return. Lump sum amounts may be transferred to your pension plan or your RRSP, effectively offsetting the income claimed. This strategy can, in many cases, save you literally thousands of dollars in taxes in the year you are entitled to the money.
You may want to transfer all of your severance pay or retiring allowance to your RRSP, but you may not be able to. Your former employer can tell you how much of your entitlement is 'eligible' for direct transfer and how much is 'non-eligible.' A direct transfer does not use up any of your available RRSP contribution limit. Some or all of the 'non-eligible' portion still may be transferred to your RRSP, but you are restricted to your available RRSP contribution limit when doing so. If you don't have enough contribution room, you may not be able to shelter the entire 'non-eligible' amount from the taxman.
How is the 'eligible' portion of your entitlement determined? Take the number of years and part-years you have been employed by the company up to and including 1995, and multiply by $2,000. If applicable, add an extra $1,500 for each year or part-year of employment prior to 1989 that employer contributions to your pension plan have not 'vested', or become available for you to take with you on retirement or termination. Clear as mud? Again, your human resources department will supply you with this number if you aren't sure how to calculate it.
It is extremely important that any direct transfer to an RRSP or pension is done properly otherwise the 'eligible' portion of your payment can be disallowed by Revenue Canada. How you handle your severance package or retiring allowance is a major financial decision, so be sure to contact a professional for advice before taking action.
For those who wish to draw an income from their investments, a unique option exists with mutual funds. This is called the Systematic Withdrawal Plan (SWP), which works by redeeming modest portions of your funds on a regular basis. It provides a steady income while keeping the majority of the portfolio invested.
A SWP has two main benefits. First is the peace of mind that comes with receiving a reliable, predictable income. Second is the knowledge that the potential to increase your nest egg is still viable since most of the money remains invested. Many people take advantage of SWPs to have funds available while avoiding large one-time withdrawals which can erode capital.
SWPs offer considerable flexibility in that they can be arranged to provide cash flow to the investor at intervals of their choice; monthly, quarterly, semi-annually etc. Also, these instructions can be changed at any time. You can receive payment in either of two methods, by cheque or by direct deposit to a bank account on any specified day.
A SWP has other benefits as well. It offers an investor the potential to weather possible ups and downs in the market because funds are redeemed over time, during different months and at different prices. Using a SWP avoids the redemption of a large amount at one time at a potentially unfavorable price. With a well-planned SWP, it is possible that the bulk of the portfolio may grow quickly enough to match or even outpace the rate of your withdrawals.
The important thing is that a SWP helps to avoid a large, single-time reduction of overall capital. However, it must be carefully monitored. The investor and his/her financial advisor must make sure that withdrawals do not exceed the performance of the mutual fund, otherwise the investment may erode considerably.
Who should use SWPs? People with substantial investment portfolios wishing to use part of their money for a special purpose. It could be an emergency fund while out of work, funds to finance a sabbatical year, or even cash to supplement your regular income. A SWP can be useful for a variety of financial goals and situations.
There are three types of income an individual can earn - interest, dividends, and capital gains. It is important to know the tax treatment of each type since what you are left with after taxes is more meaningful than the before-tax amount.
Interest income is received through means such as guaranteed investment certificates (GICs), savings accounts, treasury bills, Canada Savings Bonds and other government and corporate bonds. More generally, interest income is generated when an individual loans out his/her money. Interest is taxed at the taxpayer's full marginal tax rate, which is the amount of tax paid on the last dollar received.
Dividends are periodic payments to shareholders out of a company's earnings. Certain mutual funds, mainly equity and balanced funds investing in blue chip stocks, will pay out dividends from time to time also. For tax purposes, 125 percent of the dividends is included in the taxpayer's income and a tax credit of 13.33 percent of this grossed-up amount is allowed on dividends received from taxable Canadian corporations.
Capital gains arise on the sale of real estate (other than a principal residence), shares, mutual funds, and many other assets, for a profit. The taxable portion of a capital gain is one-half of the actual gain.
To illustrate the tax treatment on the various types of income, we will calculate the after-tax retention (what you will have to spend) of $ 1,000 for an individual.
Using rates of federal tax at 26 percent and Ontario tax of 48 percent, income received in the form of interest would leave you with about $ 607. Dividend income would provide approximately $ 761 after-tax while $ 1,000 in capital gains would leave roughly $ 806 available for the taxpayer to spend.
There are three types of income an individual can earn - interest, dividends, and capital gains. It is important to know the tax treatment of each type since what you are left with after taxes is more meaningful than the before-tax amount.
Clearly, from a taxation standpoint, our example shows that it is to your advantage to own rather than loan. In other words, returns provided from stocks, equity mutual funds, and the sale of real estate will leave you with more in your pocket than if you received similar returns in the form of interest bearing vehicles such as GICs, Canada Savings Bonds, and the like.
Keep in mind however, that besides tax treatment, you should also consider factors such as your goals and objectives, risk tolerance, and income requirements when making any financial decisions.
For most Canadians, the majority of their net worth consists of the equity in their homes. Unfortunately, residential real estate as an investment vehicle historically under-performs other vehicles, such as mutual funds, on average over the long-term.
Rather than keeping most of your money tied up in a low-growth asset, you have the option of putting your home to work for you. One effective way to accomplish this is by setting up a line of credit secured by the equity you have in your house. For a nominal fee (which is tax-deductible) a line of credit can be set up at a very attractive interest rate (at or slightly above prime) and used to build your wealth through quality investments offering greater potential returns than real estate. If the line of credit is used for investment purposes, Revenue Canada considers the interest payments to be 100% tax-deductible if the investments are outside of your RRSP.
The maximum line of credit that you can set up is normally limited to about 75% of the value of your home. For instance, if your house is worth, say $175,000, and your mortgage is completely paid off, then your maximum line of credit would be (175,000 X .75) $131,250. Any remaining balance on your mortgage reduces your maximum limit. In this example, if a mortgage of $25,000 existed on the property, the line of credit available would be (175,000 X .75 less 25,000) $106,250.
Now you can invest all or part of your available credit in a mutual fund that should average a higher rate of return than the interest rate you would be paying each year. For many lines of credit, there is significant flexibility in terms of payment options. There is no maximum payment of the outstanding balance that you are limited to (it can be paid off completely if you choose) and if you wish, you can make the minimum interest-only payment.
In addition, if the investments made are outside your RRSP, not only can you deduct the interest payments on your tax return, you are not restricted to the foreign content limit of 20% that is imposed on registered plans. You are also given the added flexibility of not being forced to begin withdrawing the amount invested when you reach 69 years of age, which can add to your tax burden.
The hot topic in the financial industry has become the use of segregated funds within your investment portfolio (segregated funds are also known as "seg" funds, guaranteed funds and protected funds depending on whether they're sold by insurance companies, fund companies or banks). In plain English, seg funds are the same as mutual funds but they are guaranteed. Wow, a guaranteed mutual fund…no more fears about losing your money….sounds good doesn't it! In fact, it sounds so good that Hogenhout and Associates now have seg funds available for our clients. But do you really want them ? Probably not. Here's why. As mentioned a seg fund is a mutual fund with a guarantee attached to it. Problem is, many investors haven't absorbed the fine print within these investments. Investors must carefully read the guarantees offered by a seg fund since they'll find the guarantees kick in only after 10 years or at death. In a few cases guarantees start after only five years. There are also differences in how much capital is protected. By law seg funds from life insurance companies must hand back 75 percent after 10 years or at death while most other funds guarantee 100 percent. The downside is that you can lose money in seg funds if you cash out before the end of the guaranteed term. I don't understand why most people who purchase seg funds don't understand this. Another thing people don't understand is how seg funds can be guaranteed. The answer is that the seg fund purchases an insurance policy within the fund; this insurance policy provides the guarantee for the seg fund. Who pays for the insurance policy ? You do ! Since seg funds are guaranteed, they charge higher management fees. These higher management fees reduce the rate of return returned to you…the investor. Say you have $10,000 in a mutual fund and it earns an average of 8 percent annually for 10 years after paying the management expense ratio (MER). If this same fund was a seg fund, it would have to pay an extra 0.5 percent in MER (to pay the insurance policy providing the guarantee) which makes your return fall from 8.0 percent to 7.5 percent. This would result in a loss of approximately $1,000 in the value of your investment, that's almost 10 percent of your initial investment. Now you know why I am not a real fan of seg funds.
"PAR" is known as the pension adjustment reversal. PAR is meant to assist employees who cease to be members of employer-sponsored registered pension plans (RPPs) or deferred profit sharing plans (DPSPs). PAR was created in the 1997 Federal budget and it applies to individuals who cease to be members of RPPs and DPSPs after 1996. While they are members of such plans, employees of such plans, employees have their RRSP deduction room (the amount they can contribute to their RRSPs) reduced by a "pension adjustment" (PA). The PA is a reported amount that essentially reflects the value of their benefits accumulating in the RPP or DPSP. However, an employee who leaves his or her employment before retirement may receive a termination benefit that is less than the PA (for example, where the benefits under the RPP or DPSP have not fully vested in the employee). In such a case, there is a potentially unfair result - the employee will have seen his or her RRSP deduction room reduced because of the past participation in the RPP or DPSP, but the employee will not receive all of the benefits under the RPP or DPSP. The PAR is meant to remedy this result, by restoring the RRSP deduction room that was "given up" during the years of membership in the RPP or DPSP. Generally the PAR will equal the amount by which the previously reported PA exceeds the termination benefit received out of the RPP or DPSP. The PAR is added back to the employee's RRSP deduction room in the year in which the employee ceases to be a member of the RPP or DPSP, normally meaning the year of termination. The RPP or DPSP administrator is required to report the employee's PAR to Revenue Canada and to the employee ceases to belong to the RPP or DPSP. As noted, the PAR is then added to the employee's RRSP deduction room for that year.