Topic: Tax Tips

Changing Your Corporation’s Fiscal Period

A Canadian corporation’s first fiscal year can end up to 53 weeks after the date of incorporation. Once the fiscal period has been chosen, it cannot be changed, unless by operation of law, without the permission of the Canada Revenue Agency (“CRA”).

The CRA is concerned about taxpayers changing fiscal periods with the motive of minimizing taxes. As such, the CRA requires that there must be a sound business reason to change a corporation’s fiscal period. Some examples of such business reasons include the following:

  • Changing a fiscal period to be in line with a parent or associated company; or
  • Changing a fiscal period to end at a time when inventory is seasonally low

Over the last number of years, the CRA has been denying requests for a change in fiscal period where it does not see sufficient merit. The bar has been set higher than in the past, when most reasonable requests were allowed. The presumption should no longer be that a reasonable request will automatically be allowed. You can anticipate having to prove your case to the CRA.

In order to request a change in your corporation’s fiscal period, write a letter to your tax services office and be sure to include details as to why you are requesting a change, as well as relevant supporting documents. The letter should be signed by the taxpayer or an authorized individual. Requests should be submitted well in advance of the desired new fiscal year end, as the request has to be approved before the new fiscal period can be used.  Changing a fiscal period retroactively is generally not permitted.

There are certain circumstances in which approval is not required to change a fiscal period – these include the following:

  • The corporation undergoes an acquisition of control by an unrelated person or group of persons
  • The corporation amalgamates with another Canadian corporation[1]
  • The corporation has been wound-up, resulting in a short fiscal period
  • The corporation becomes or ceases to be:
    • exempt from income tax;
    • a resident of Canada; or
    • a Canadian-controlled private corporation

The CRA’s very limited information regarding changing a year end can be viewed here.  The CRA’s cancelled Interpretation Bulletin IT-179R – Change of Fiscal Period had helpful information but can no longer relied upon.


[1] However, the CRA has stated in Information Circular 88-2 General Anti-Avoidance Rule – Section 245 of the Income Tax Act (paragraph 21), that it considers an amalgamation conducted under subsection 87(1) solely for the purposes of creating a year end under paragraph 87(2)(a) to be subject to the GAAR.

Changes to the T1134 deadline

Form T1134, Information Return Relating to Controlled and Non-Controlled Foreign Affiliates is a foreign reporting form which must be filed by all Canadian resident taxpayers (corporations, individuals and trusts), and partnerships for any year in which the taxpayer has an interest in a controlled or non-controlled foreign affiliate, at any time in the year.

The term ‘foreign affiliate’ means a non-resident corporation in which the taxpayer has at least a 1% direct ownership interest, and at least a 10% combined ownership interest when considering the interest of the taxpayer and each person related to the taxpayer. A “controlled” foreign affiliate is a foreign affiliate that is controlled by the taxpayer or would be controlled by the taxpayer if the taxpayer owned all of the shares of the foreign affiliate that are held by four or less Canadian resident shareholders and persons who deal at non-arm’s length with the taxpayer or the other Canadian resident shareholders. In stacked company structures, only the lowest tier Canadian subsidiary is required to file Form T1134.

If certain thresholds are not met, there is no filing requirement for Form T1134. In particular, exemptions apply if:

  • The total cost to the reporting taxpayer of the interest in all foreign affiliates at any time in the year is less than $100,000,

AND

  • The foreign affiliate is deemed to be “dormant” – this is the case if the foreign affiliate had gross receipts of less than $25,000 in the year, and at no time in the year had assets with a total fair market value of more than $1 million.

The current filing deadline for Form T1134 is 15 months after the taxation year end of the reporting taxpayer.  For example, the due date for the 2017 T1134 Form for an individual with a December 31 taxation year end will be due on March 31, 2019.   However, as proposed in the 2018 Federal Budget, this deadline will be accelerated to allow the CRA to have the information sooner for their audit purposes.  The new proposed deadline is 12 months after the taxation year end of the reporting taxpayer for taxation years beginning in 2020 and 10 months thereafter.  

The purpose of the form is to require taxpayers to report various financial information regarding a foreign affiliate for CRA’s risk assessment purposes.  For instance, Foreign Accrual Property Income or “FAPI” represents passive income earned by a controlled foreign affiliate, which is imputed and taxable in the hands of a Canadian resident shareholder as earned.  Form T1134 provides a tracking mechanism for the CRA to match the information reported on the form to the income tax filings of such Canadian resident taxpayers.

It is important that Form T1134 be filed on time.  The penalty for not filing this information return is $25 for each day late, to a maximum of $2,500 for each supplement that is required for a foreign affiliate.

Tax Planning Bomb Shell

“Changes to strategies that have been the basis
for shareholder remuneration planning for decades
will be eliminated”

On July 18, 2017 the Department of Finance issued draft legislation which, if passed into law, will limit many of the advantages of using private corporations.  The changes are fundamental and will have widespread impact.

The changes fall into four basic categories as follows:

  • Income splitting
  • Capital gains exemption
  • Capital gains within a corporate group
  • Deferral of tax using private corporations

Income Splitting

Beginning in 2018, the kiddie tax rules will be extended substantially.  Instead of being limited to persons under the age of 18, they will now apply to all Canadian resident individuals where a person receives income from a related private corporation, unless the amount is reasonable in the circumstances having regard to certain criteria.  These criteria include the labour contribution of the individual and the capital committed.  A more stringent test applies for persons between the ages of 18 and 24.  Essentially the idea is to determine the amount of compensation (in whatever form) that would be reasonable in the circumstances, and any amount in excess of this would become part of the individual’s “split income” taxable at the top personal tax rate.

Obviously rules such as these are complex, and require detailed study.  They will also create a great deal of uncertainty and subjectivity as to how they are applied.

Capital Gains Exemption

Three changes are proposed to the capital gains exemption.  Individuals under the age of 18 would no longer be able to claim the capital gains exemption.  More precisely, gains accrued during a taxation year before the individual attains the age of 18 will not be eligible.  Secondly, any amount of a taxable capital gain which is included in split income will not be eligible for the capital gains exemption.  Lastly, gains accrued during the time that property was held by a trust will no longer be eligible.

These new rules will come into effect in 2018.  An election will be available to realize gains on hand in order to provide transitional relief. Curiously a date in 2018 may be selected for this purpose.

We anticipate that this election will be widely used, and that valuations will be required in an enormous number of cases in 2018 to support the value used.

Capital Gains within a Corporate Group

It has become popular to realize capital gains within a corporate group, and pay out the proceeds, particularly via the capital dividend.  This is because the tax rate on a capital gain (realized within the corporate group and distributed to shareholders) is lower than the tax rate on taxable dividends.  As a result of this becoming widespread, steps are being taken to close down this planning approach.

The draft legislation will extend the scope of section 84.1 which results in a dividend rather than a capital gain where the section is triggered.  Because the capital gain will be recharacterized as a dividend, no amount will be added to the capital dividend account.  There may also be a denial of an increase in the adjusted cost base, potentially resulting in double taxation which, according to the materials, is consistent with the intent of the provisions.  Unfortunately, no distinction is made between the application of this provision to post-mortem and pre-mortem planning.

An additional anti-avoidance rule will be inserted to deal with surplus stripping via capital gains, in the event that new section 84.1 is not sufficient, on its own, to deny the benefit.

This change is to be effective from announcement date (i.e. July 18, 2017).

Accumulating Funds in Private Corporations

While the first three items above are dealt with in 27 pages of draft legislation, the issue of accumulating funds in private corporations is dealt with conceptually, explaining the issues, and outlining two possible approaches.  In simple terms, the Department of Finance has identified that a significant tax deferral arises where active business income is retained within a corporate group.  Because corporate tax rates are so much lower than personal tax rates, there has been a continuing trend to retain excess funds within the corporate group and make passive investments, thereby deferring the tax that would be paid if the excess funds were distributed as a dividend.  Nobody should be surprised at this.  Indeed, one should be surprised if anyone is surprised!

This tax deferral is considered to give owners of private corporations an advantage over their counterparts who do not have such opportunities (for example a person who receives a salary).  The starting point for accumulating investment assets is clearly different when a corporate tax rate of 15% or 25% is applied to the income rather than a personal tax rate of 53%.  How to design a system to deal with this is conceptually very difficult.  Whether or not taking action is appropriate is another very relevant question.

In this, the Department of Finance has asked for input from interested parties, perhaps in part because there is no simple solution to this issue.

Implications

The implications of these potential changes are significant.  Not only will they limit income splitting opportunities, multiplication of the capital gains exemption, and other tax strategies, they will also add very significant complexity to the taxation of private corporations and their shareholders.  Given the additional complexities created in recent years with changes to section 55 (Safe Income and Intercorporate Dividends) and the changes to the Small Business Deduction (expansion of circumstances where the $500,000 small business limit must be shared), this will clearly compound upon what is already a very difficult area.

Introducing a reasonableness test, failing which dividends from private corporations will be taxed at the top tax rate, is a sweeping change, which will confer a huge amount of discretion onto CRA.  Limiting the capital gains exemption to natural individuals, and preventing its use where shares are held through trusts, will alter the landscape considerably.

While the Department of Finance has indicated that it wishes to conduct a consultation on these issues, with a deadline for submissions in early October, our experience in recent years indicates that once proposals are at the draft legislation stage, little in the way of substantial change can be brought about.

We will be reviewing these rules in greater detail, and issuing further notes on various aspects of the proposals, as well as any changes to them which may arise.


TAX TIP OF THE WEEK is provided as a free service to clients and friends of the Tax Specialist Group member firms. The Tax Specialist Group is a national affiliation of firms who specialize in providing tax consulting services to other professionals, businesses and high net worth individuals on Canadian and international tax matters and tax disputes.

The material provided in Tax Tip of the Week is believed to be accurate and reliable as of the date it is written. Tax laws are complex and are subject to frequent change. Professional advice should always be sought before implementing any tax planning arrangements. Neither the Tax Specialist Group nor any member firm can accept any liability for the tax consequences that may result from acting based on the contents hereof.

Major changes to the Voluntary Disclosures Program

“relief from penalties will be significantly curtailed”

The Voluntary Disclosures Program (VDP) is a CRA administrative program that allows taxpayers to voluntarily come forward and correct up to 10 years of errors or omissions in their Canadian tax affairs with relief from prosecution and penalties.  There can also be relief from interest for amounts owing for statute barred years.

In Tax Tip 16-01 we recommended that taxpayers with unreported income make a voluntary disclosure (Disclosure) as soon as possible. Now there may be more reason to act quickly.  Under proposed changes to the VDP (Draft Information Circular IC00-1R6), the relief from penalties will be significantly curtailed in certain common scenarios after December 31, 2017.

Under the new VDP program, there will be two tracks for income tax disclosures, being the General Program and the Limited Program.  If a Disclosure is accepted under the General Program, the Taxpayer will be eligible for penalty relief and partial interest relief, in a way similar to what is provided under the current program.  Although not stated in draft IC00-1R6, it appears that non-compliance that could result in criminal prosecution will not be eligible for the General Program.

VDP applications that disclose “major non-compliance” will be processed under a new “Limited Program” and, if accepted, relief will only be provided from prosecution and gross-negligence penalties.  All other penalties such as late-filing penalties will be applicable and no interest relief will be provided.

The Limited Program will be applicable in any of the following situations:

  • active efforts to avoid detection through the use of offshore vehicles or other means
  • large dollar amounts (not defined)
  • multiple years of non-compliance
  • a sophisticated taxpayer
  • the disclosure is made after an official CRA statement regarding its intended focus of compliance or following CRA correspondence or campaigns
  • any other circumstance in which a high degree of taxpayer culpability contributed to the failure to comply

For example, the CRA has sent letters to taxpayers regarding receipt of funds reported by banks and the letters provide a note for the taxpayers to consider reporting income and Form T1135 under the VDP.  If the disclosure is made by such a taxpayer after 2017, it will come under the Limited Program with no relief for late filing penalties or interest.  In addition, it would appear that any late filing of foreign reporting forms will also be subject to late-filing penalties of $2,500 per year per form under the Limited Program from 2018 onwards.

The new VDP program eliminates the protection provided under the current no-names disclosure process and replaces it with  a no-names pre-disclosure discussion process that does not protect the Taxpayer if they are approached by the CRA before filing a “named” voluntary disclosure, with a completed and signed Form RC199 to mark the Effective Date of Disclosure.

Taxpayers and their advisors should consider whether a voluntary disclosure is desired, even if it is for something as simple as not filing Forms T1135 for required years.   If a voluntary disclosure is required, it should be made before the end of 2017 before the new limitations become applicable.


TAX TIP OF THE WEEK is provided as a free service to clients and friends of the Tax Specialist Group member firms. The Tax Specialist Group is a national affiliation of firms who specialize in providing tax consulting services to other professionals, businesses and high net worth individuals on Canadian and international tax matters and tax disputes.

The material provided in Tax Tip of the Week is believed to be accurate and reliable as of the date it is written. Tax laws are complex and are subject to frequent change. Professional advice should always be sought before implementing any tax planning arrangements. Neither the Tax Specialist Group nor any member firm can accept any liability for the tax consequences that may result from acting based on the contents hereof.

Canadian Tax Treatment of Certain Florida and Delaware Partnerships

the CRA views these entities to be corporations for Canadian income tax purposes.

Residents of Canada who currently invest in Delaware or Florida Limited Liability Partnerships (“LLPs”) and Limited Liability Limited Partnerships (“LLLPs”) should be aware of recent announcements made by the Canada Revenue Agency (“CRA”). If action is not taken by the end of 2017, these vehicles may yield unintended, but significantly adverse tax consequences to Canadian partners.

Recently,  the CRA has stated that an advance tax ruling will be released concluding that, rather than being partnerships, Delaware and Florida LLPs and LLLPs the CRA views these entities to be corporations for Canadian income tax purposes.

From a cross-border tax perspective, partnerships allow the US and Canadian tax systems to integrate well as the income tax implications under both systems are the same. The CRA’s ruling that these Florida Delaware LLLPs and LLPs entities are corporations for Canadian tax purposes (not partnerships) eliminates this integration and could result in significant double taxation for Canadian investors who hold these US investments.

Normally, US partnerships are flow-through entities for Canadian tax purposes. This means the partnership income is taxed in the hands of the partners both in the US and in Canada. Thus, any taxes paid in the US by a partner may be used as a credit to deduct against the Canadian tax payable on the US source partnership income.

This treatment will end as a result of the CRA’s pending ruling. Canada will levy tax on the LLP or LLLP’s income as if it were a foreign corporation.  This basis of taxation is very different than the partnership basis used for US tax purposes and can result in significantly higher combined tax rates than under the status quo.

The classification of these entities as corporations for Canadian purposes also means that they may be subject to Canada’s foreign affiliate taxation regime and that partners may have to file a Form T1134, annually.

The CRA has stated that it will treat existing LLPs or LLLPs as a partnership for all years prior to 2018, provided the following conditions are met:

  1. The LLP or LLLP was formed and carried on business before July 2016;
  2. The taxpayers intended that the LLP or LLLP be classified as a partnership for Canadian tax purposes and have reported the income in this manner in prior years;
  3. No member, or the entity itself, has ever taken the position that the entity is anything other than a partnership for Canadian tax purposes; and
  4. The LLP or LLLP is converted to a legal form that is generally recognized as a partnership for Canadian tax purposes, no later than 2018.

If these conditions are met the CRA will also allow the conversion of a LLP or LLLP to a limited or regular partnership on a tax free basis.

It can take time to manage the conversion from an LLP or LLLP to a different form of US partnership so don’t delay.  There may also be logistical issues.  For example, US investors may be reluctant to convert the legal form of the partnership due to the loss of additional liability protection.  Also, supplier agreements, contracts, finance documents and licenses may have to be revised.  There are solutions to these problems but they take time and must be implemented before January 1, 2018.

At Cadesky Tax we are well prepared to assist you with managing this change to the treatment of LLLPs and LLPs for Canadian tax purposes.


TAX TIP OF THE WEEK is provided as a free service to clients and friends of the Tax Specialist Group member firms. The Tax Specialist Group is a national affiliation of firms who specialize in providing tax consulting services to other professionals, businesses and high net worth individuals on Canadian and international tax matters and tax disputes.

The material provided in Tax Tip of the Week is believed to be accurate and reliable as of the date it is written. Tax laws are complex and are subject to frequent change. Professional advice should always be sought before implementing any tax planning arrangements. Neither the Tax Specialist Group nor any member firm can accept any liability for the tax consequences that may result from acting based on the contents hereof.

Upstream Loans

taxpayers may need to act now 

Prior to 2011, upstream loans were used to defer income offshore by having a foreign affiliate make a loan to a Canadian shareholder. In 2011, the government introduced upstream loan rules (grandfathered to take effect on August 20, 2016 for loans made prior to August 19, 2011) to curb indefinite offshore income deferral. Given these recent changes, the government’s focus on these types of loans and the impending end of the grace period many taxpayers may need to act now to ensure that their upstream loans will not attract adverse tax consequences.

Generally, the upstream loan rules require an income inclusion in Canada where a foreign affiliate of a Canadian taxpayer makes a loan to a person (or to a partnership) that is a “specified debtor” in respect of the Canadian taxpayer.

A “specified debtor” includes the taxpayer resident in Canada, and also a person who does not deal at arm’s length with the taxpayer, with the exception of a controlled foreign affiliate. A specified debtor also includes a partnership in which the non-arm’s length person and the taxpayer is a member.

There are certain exceptions to the upstream loan rules. For example, the rules do not apply to a loan that is repaid within 2 years of the day when the loan was made. The upstream loan rules will also not apply if the loan is made in the ordinary course of the business of the creditor, and bona fide arrangements were made for repayment within a reasonable time.

The introduction of upstream loan rules is similar to the domestic shareholder loan rule contained in subsection 15(2). However, the upstream loan rule is broader than subsection 15(2) because it is also applicable to Canadian corporations. This can often catch taxpayers off guard.

Consider the following example, where Canco wholly owns foreign affiliate A (Forco A):

In this example, Canco will have an income inclusion of the loan amount pursuant to the upstream loan rules if no other exception applies.

Certain loans are subject to a five-year grandfathered repayment period. If loans were entered prior to August 19, 2011, they will not be included as income as long they are repaid before August 19, 2016.


TAX TIP OF THE WEEK is provided as a free service to clients and friends of the Tax Specialist Group member firms. The Tax Specialist Group is a national affiliation of firms who specialize in providing tax consulting services to other professionals, businesses and high net worth individuals on Canadian and international tax matters and tax disputes.

The material provided in Tax Tip of the Week is believed to be accurate and reliable as of the date it is written. Tax laws are complex and are subject to frequent change. Professional advice should always be sought before implementing any tax planning arrangements. Neither the Tax Specialist Group nor any member firm can accept any liability for the tax consequences that may result from acting based on the contents hereof.

Voluntary Disclosures – Time is of the Essence

“the initial submission can be made quickly, on a no-names basis

Under the voluntary disclosures program (“VDP”) the Canada Revenue Agency (“CRA”) has the authority to waive penalties, reduce interest otherwise payable and not lay criminal charges (if applicable) for taxpayers who voluntarily disclose unreported income or file missing information returns. A voluntary disclosure will not be accepted if enforcement action (including a request for a tax return, notification that an audit will begin, or various other actions) has been initiated by the CRA or a provincial tax authority. There is good information about the VDP on the CRA’s website.

In Tax Tip 13-10 we advised that the proliferation of information exchange agreements, cooperation between taxing authorities and increased information reporting requirements will make it easier for the CRA to find unreported income and that use of the VDP should seriously be considered.

Although Switzerland will only be initiating its first automatic information exchange with Canada by 2018,  recent actions taken by some Swiss banks have made it more likely that the CRA will learn about these foreign accounts even sooner.

Some Swiss banks are now requiring that their Canadian clients certify that the income and capital gains earned in the account have been disclosed to the CRA. UBS has gone as far as to advise their clients to provide account closing instructions if this certification could was not made by December 31, 2015.  Failing receipt of the certification, UBS stated it would terminate its banking relationship with these clients and likely mail correspondence rather than retain the mail (as was done in the past). Presumably funds will be mailed or transferred electronically to other bank account(s) owned by these clients. If the electronic transfer is made to a Canadian institution and is more than $10,000 it will be reported to the CRA.  This reporting obligation is described in Tax Tip 14-02.

In cases where assets and/or related income have not been declared we have been able to appease the Swiss banks if we confirm that a taxpayer is making a submission under the VDP. However, now that the December 31, 2015 deadline has passed, this certification may be too late and the bank may be in the process of closing the account and forwarding the funds back to Canada.

If so, the CRA will likely learn about the existence of these foreign investment accounts in 2016. If a voluntary disclosure is not initiated in time, tax penalties, full interest and possible criminal charges and fines could be assessed.

We recommend that taxpayers with unreported income make a voluntary disclosure as soon as possible in order to avoid these results.  In many cases the initial submission can be made quickly, on a no-names basis  if not all the required information is readily available.


TAX TIP OF THE WEEK is provided as a free service to clients and friends of the Tax Specialist Group member firms. The Tax Specialist Group is a national affiliation of firms who specialize in providing tax consulting services to other professionals, businesses and high net worth individuals on Canadian and international tax matters and tax disputes.

The material provided in Tax Tip of the Week is believed to be accurate and reliable as of the date it is written. Tax laws are complex and are subject to frequent change. Professional advice should always be sought before implementing any tax planning arrangements. Neither the Tax Specialist Group nor any member firm can accept any liability for the tax consequences that may result from acting based on the contents hereof.

Special Update on Taxation of Stock Options

“Only new stock options affected by tax changes”, says Minister Morneau.

Today new Federal Finance Minister Morneau said that any changes to the taxation of stock options will only affect stock options issued from the date the changes are announced.  “Any decisions we take on stock options will affect stock options issued from that date forward,” said the Minister.

Any stock option issued prior to that date will be treated under the tax regime that was in effect at the time.

Although the wording in this announcement is not “crystal clear”, it appears that stock options granted before the date of any announced changes to the taxation of stock options will remain subject to the old rules.  Currently, if certain conditions are met, a deduction of 50% of the benefit realized on exercise of a stock option can be taken as a deduction.  This essentially means that only half of the stock option benefit is subject to tax.

During the Federal election campaign, the Liberals announced that the deduction allowed for stock options would be limited to $100,000 annually, because stock options are widely used as a tax perk by wealthy Canadians, and are not normally available to the middle class.  There has been considerable speculation as to how the proposed changes would be implemented, and even more significantly, when they would apply.  Many people thought that stock options exercised in 2015 would benefit from the full 50% deduction, whereas if exercised in 2016, the deduction might be limited to $100,000.  Consequently, many people had been exercising stock options, or at least considering this, before the end of the year.

The Minister’s announcement seems to provide some comfort that existing stock options and those created before any changes are announced, whether exercised or not, will continue to benefit from the full 50% deduction, where eligible, and that only stock options granted after a date in the future on which the new rules will be explained in more detail will be affected.

In any event, because of the proposed tax rate increase, which may apply from 2016 onwards, of 4% for high income individuals (taxable income over $200,000), it may still be beneficial to exercise stock options in 2015 rather than 2016.

It should be noted that the tax considerations are only one factor in determining whether or not to exercise stock options.  There are other issues to consider, such as whether to hold the shares or sell the shares, which is a financial and investment decision.  There is also the funding of the amount necessary to exercise the stock options and corresponding taxes payable on benefits realized.  Lastly, it should be noted that if the stock decreases in value from the price on the exercise date, the decline in value will be a capital loss.  The stock option benefit is considered employment income, and a capital loss cannot be applied to reduce employment income.

A by-product of the Minister’s announcement is that it may be possible to grant additional stock options today which will fall under the grandfathering.  The window of opportunity may be short-lived as no one can predict when the rules will be outlined, which will mark the effective date of the change (there could be an announcement in December, or the matter could be raised for the first time in a Federal Budget which might possibly be scheduled for February 2016).  There may be a window of opportunity, but it may not be a large one.  In any event, granting of a stock option is not itself normally a taxable event.  Thus, there would appear to be little downside to accelerating the granting of stock options in suitable circumstances.

For an individual consultation concerning stock options, please contact us.


TAX TIP OF THE WEEK is provided as a free service to clients and friends of the Tax Specialist Group member firms. The Tax Specialist Group is a national affiliation of firms who specialize in providing tax consulting services to other professionals, businesses and high net worth individuals on Canadian and international tax matters and tax disputes.

The material provided in Tax Tip of the Week is believed to be accurate and reliable as of the date it is written. Tax laws are complex and are subject to frequent change. Professional advice should always be sought before implementing any tax planning arrangements. Neither the Tax Specialist Group nor any member firm can accept any liability for the tax consequences that may result from acting based on the contents hereof.

Back to the Future

“The expected increase in personal tax rates is significant and warrants a review of tax planning strategies prior to January 1, 2016.”

The recent election of a Majority Liberal Government in Ottawa will likely result in changes to personal income tax changes rates.  In particular, the Liberals promised to:

  • Reduce the second lowest tax rate to 20.5% from 22%;
  • Increase the tax rate on incomes over $200,000 to 33%, from 29%.

When these changes are implemented (we have assumed  January 1, 2016) the top marginal tax rate in Ontario, for example, will increase from 49.53%, to 53.53%.  We haven’t seen top marginal rates this high since 1994 and 1995 when the top marginal rate on regular income was  53.19%.  In those years, dividends were subject to tax at 35.92% and capital gains at 39.89% (in Ontario).  The table at the end of this tip illustrates the top marginal rates for 2015 and 2016 assuming the Liberal proposals become effective January 1, 2016 and that proposals regarding non-eligible dividends announced in the 2015 federal budget apply.

With the proposed tax increases, the top marginal rate on dividends (eligible or “non-eligible”) will be even higher, at 39.34% and 45.3% respectively, than the 1994 rate of 35.92%.  The effective rate on capital gains of 26.76% will be lower than the 1994 rate of 39.89% but only because the capital gains inclusion factor is now 50% instead of 75%.  If capital gains had only been 50% taxable in 1994, the comparative rates would have been 26.59%, just below the 2016 number.

The expected increase in personal tax rates is significant and warrants a review of tax planning strategies prior to January 1, 2016.

With a 4% increase in the regular top marginal rate (almost 8% in Alberta due to  the combination of the Federal and Provincial changes) and increases in dividend rates of approximately 5% (over 10% on eligible dividends in Alberta),  accelerating income inclusions may be warranted.

Some ways to accelerate income in 2015 include paying bonuses that would normally be  accrued but not paid until after 2015.  In addition, consider paying dividends (whether eligible or “ineligible”) in 2015 if the funds will be required in the next few years. If cash flow does not permit the payment of the actual cash dividends, the amount can be added to a shareholder loan account if appropriate documentation is prepared to confirm the declaration and payment of the dividends, as well as the requirement to credit the shareholder loan account.  We recommend that promissory notes also be created for these types of payments.

Deferring discretionary deductions such as RRSP’s and loss carry forwards to future years when the top tax rate is higher may also be beneficial.

The expected increase in the top marginal tax rates in 2016 will affect taxpayers in all provinces and territories.  Regular owner manager remuneration techniques will be less efficient than they used to be, after 2015.  We recommend that you consider whether withdrawing funds in 2015, to prepay tax at a lower rate than 2016. In addition, deferring discretionary deductions where practical to 2016 or a subsequent year may be wise.

As with any tax planning , there is no rule of thumb.  Deciding how best to withdraw corporate funds to pay personal expenses will largely depend on the facts.  We would be happy to help you determine what is best in your situation.

Ordinary Income Capital Gains Canadian Dividends Eligible Canadian Dividends Non-Egilible
2015 2016 2015 2016 2015 2016 2015 2016(1)
Federal 29.00% 33.00% 14.50% 16.50% 19.29% 24.81% 21.22% 26.30%
Alberta 40.25% 48.00% 20.13% 24.00% 21.02% 31.71% 30.84% 40.40%
British Columbia 45.80% 47.70% 22.90% 23.85% 28.68% 31.30% 37.99% 40.61%
Manitoba 46.40% 50.40% 23.20% 25.20% 32.26% 37.78% 40.77% 45.69%
New Brunswick 54.75% 58.75% 27.38% 29.38% 38.27% 43.79% 46.89% 51.75%
Newfoundland and Labrador 43.30% 48.30% 21.65% 24.15% 31.57% 38.47% 33.26% 39.40%
Northwest Territories 43.05% 47.05% 21.53% 23.53% 22.81% 28.33% 30.72% 35.72%
Nova Scotia 50.00% 54.00% 25.00% 27.00% 36.06% 41.58% 41.87% 46.97%
Nunavut 40.50% 44.50% 20.25% 22.25% 27.56% 33.08% 31.19% 36.35%
Ontario 49.53% 53.53% 24.76% 26.76% 33.82% 39.34% 40.13% 45.30%
Prince Edward Island 47.37% 51.37% 23.69% 25.69% 28.70% 34.22% 38.74% 43.87%
Quebec 49.97% 53.31% 24.98% 26.65% 35.22% 39.83% 39.78% 43.84%
Saskatchewan 44.00% 48.00% 22.00% 24.00% 24.81% 30.33% 34.91% 40.06%
Yukon 44.00% 48.00% 22.00% 24.00% 19.29% 24.81% 35.18% 40.18%

1 Assumes the increase to 2016 personal tax rates on non-eligible dividends announced in the 2015 federal budget will apply.

Another Reason to Consider the Disability Tax Credit

 

“In order for the election to be valid each electing beneficiary must be eligible for the DTC.”

In  Tax Tip 12-23  we discussed some of the tax benefits that stem from the Credit for Mental or Physical Impairment, usually called the disability tax credit,  (“DTC”)  The process for applying for the DTC is not particularly onerous and can provide much more tax relief than just  a modest non-refundable tax credit.  Eligibility for the DTC provides tax relief to the affected person and their family in the form of benefits such as: 

  • An increased spectrum of eligible medical expenses;
  • Additional employment related deductions;
  • Increased child care expense limits for a longer period of time;
  • Possible increased child benefit payments;
  • Rollovers of RRIF or RRSP funds on death, to an eligible child;
  • Potential access to a parent’s locked in RRIF or RRSP funds;
  • Eligibility for the benefits of a Registered Disability Savings Plan.
  • Enhanced RESP rules;
  • Additional fitness and arts credits

While this is not an exhaustive list, we can now add a significant new benefit to it.

 After December 31, 2015 most trusts and estates will be subject to tax at the top marginal tax rate, with the exception of a “graduated rate estate” (“GRE”) or a “qualified disability trust” (“QDT”).  The new rules were addressed in Tax Tips 14-22 and 14-23. and are relevant for both new and existing estate plans.  .

Much has been written about the GRE exception so this tax tip will address some issues regarding the QDT exception.  A QDT can be created in a person’s Will if the executors or trustees jointly elect with one or more beneficiaries (“electing beneficiary or beneficiaries”) under the trust to be a QDT.  In order for the election to be valid each electing beneficiary must be eligible for the DTC (and the election must be made in the T3 return for the trust’s tax year). No beneficiary who makes this election can elect with any other trust to be a QDT, and the trust must be factually resident in Canada. Qualification as a QDT will be  determined annually.

The main benefit of QDT status is access to graduated tax rates inside the trust instead of all the trust’s income being taxed at top rates.  The QDT exception was created in order to allow funds to be managed by trustees as opposed to a person suffering from a severe mental or physical infirmity (or their representative).  If the exception was not created, the only way to access graduated tax rates for such a beneficiary would be to use the preferred beneficiary election and treat some or all of the trust’s income to be that of the eligible beneficiary. There are non tax complications that could stem from the preferred beneficiary election so the QDT exception is a welcome relief. However, the QDT benefits are only intended for the eligible beneficiaries. If low rate income is paid to a non-eligible beneficiary a “recovery tax” will be imposed on the trust as it will no longer be a QDT.

Identifying eligibility for the DTC at any time can result in thousands of dollars in tax refunds from retroactive claims and allow for entitlement to other incentives such as those noted above.  With the new QDT exception from top marginal tax rates for testamentary trusts we further  encourage you to consider a beneficiary’s possible  eligibility for the DTC.


TAX TIP OF THE WEEK is provided as a free service to clients and friends of the Tax Specialist Group member firms. The Tax Specialist Group is a national affiliation of firms who specialize in providing tax consulting services to other professionals, businesses and high net worth individuals on Canadian and international tax matters and tax disputes.

The material provided in Tax Tip of the Week is believed to be accurate and reliable as of the date it is written. Tax laws are complex and are subject to frequent change. Professional advice should always be sought before implementing any tax planning arrangements. Neither the Tax Specialist Group nor any member firm can accept any liability for the tax consequences that may result from acting based on the contents hereof.