Tax Implications of Investing

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1 GRAHAM THIESSEN BUCHANAN BARRY Tax Implications of Investing BY GRAHAM THIESSEN In the world of investing, there are many factors outside of your control that can disturb your investments and ultimately your portfolio performance. However, there are factors that you can control, like accounting for taxation. TO HELP MAXIMIZE YOUR AFTER-TAX RATES OF RETURNS, WE FOCUS ON THE TYPES OF TAXES YOU FACE AS AN INVESTOR AND CONSIDERATIONS FOR YOUR INVESTMENT STRATEGY In the world of investing there are many factors outside of your control. Political events, natural disasters, investor sentiment, and the like can impact your investments and ultimately your portfolio performance. There are other factors which you can control which in turn may also impact your portfolio results, like asset allocation, security selection and accounting for taxation. In this article, we will focus on taxation to help you better understand, from a high level, the types of taxes you face as an investor and considerations for your investment strategy in order to help maximize your after-tax rates of return. MCLEAN & PARTNERS WEALTH MANAGEMENT 1

2 What is taxable? THE MOST TAX EFFICIENT RETURNS ONE CAN GENERATE IN THEIR PERSONAL ACCOUNTS ARE THROUGH CANADIAN DIVIDENDS AND CAPITAL GAINS In the table below we have highlighted the six most common types of accounts investors used as part of their overall investing landscape. The 2014 table also shows which applicable taxes are payable on an annual basis within each of the accounts. Personal/Joint Account RRSP/RRIF Account Tax Free Savings Account (TFSA) Interest Income Eligible Canadian Dividends (a) Foreign Dividends (b) Capital Gains (c) 39% 19.3% 39% 19.5% 0% 0% Variable 0% 0% 0% Variable 0% RESP Account 0% 0% Variable 0% Personal Holding Company (PHC) (d) Family Trust Account 42.5% 19.3% 42.5% 21.0% 39% 19.3% 39% 19.5% a The rates apply to the actual amount of the eligible dividends received from taxable Canadian corporations. These dividends must be designated by the payor corporation as an eligible dividend for the above rates to apply. If ineligible dividends are issued, different tax rates will apply. b The tax rate is the Canadian tax portion only. Foreign dividends may be subject to additional tax rates of the payor corporation s country. These rates would vary depending on the country of the payor corporation. Typically a credit may be claimed amongst Canadian taxes for foreign taxes paid, subject to tax treaty provisions. c The rates apply to the actual amount of the capital gain. d The rates reflect the total combined tax paid personally and corporately on full distribution from the PHC, net of the refundable dividend tax on hand (RDTOH). e The rates indicated above are based on Alberta and the highest marginal tax bracket. Specific tax rates will vary by province or territory and by your marginal tax bracket. Alternative minimum tax provisions have not been considered. Every individual s circumstances will vary and several factors may need to be considered which could affect the tax rates significantly. MCLEAN & PARTNERS WEALTH MANAGEMENT 2

3 Which account is most appropriate? You can see how the after-tax return of an investment can vary dramatically depending on the type of account you hold the investment in. For example, $10,000 of interest income in a personal account could leave you as little as $6,100 to spend or re-invest. If that same $10,000 was generated by Canadian dividends you would have $8,071 after-tax or 32% more money! So let s look at each of the various account types and consider which types of investments might be most appropriate. PERSONAL ACCOUNTS (NON-REGISTERED) The most tax efficient returns one can generate in their personal accounts are through Canadian dividends and capital gains. Tax rates on each are less than 20% and capital gains can be offset with capital losses in the year incurred, or losses can be carried back up to seven years. Capital losses can also be carried forward indefinitely. RRSPS/RRIFS RRSPS/RRIFS ARE SOUND IF YOU HAVE A TIMELINE OF FIVE YEARS OR MORE BEFORE YOU PLAN ON WITHDRAWING FROM THE ACCOUNT Earning interest income (from bonds, GICs, etc) is generally the most punitive for investors, so sheltering interest income in your registered accounts is wise. However, once income is pulled out from the registered accounts, it is considered income and may then subject the owner to the most punitive of taxes. As a general rule, this approach is sound if you have a timeline of five years or more before withdrawing from the account. However, if you plan to withdraw the money from the registered account within five years of contributing, alternative strategies would be worth pursuing. Secondly, owning U.S. stocks in registered accounts might be worth considering. While foreign dividends may be subject to withholding taxes, U.S. stock dividends avoid any U.S. withholding taxes, which can be as high as 30%. MCLEAN & PARTNERS WEALTH MANAGEMENT 3

4 TFSA TFSA AND RESPS ARE SIMILAR IN THAT MONIES GOING INTO THE ACCOUNTS ARE TAX-PAID, PERSONAL MONEY AND HAVE NO TAX LIABILITIES ON ANY FORM OF INCOME EARNED Given that the monies going into a TFSA account is tax-paid and personal money, there are no tax liabilities on any form of income earned nor on the immedial withdrawal of money from this account. All investments may be considered good alternatives here. The only consideration is that foreign stocks which pays dividends, including U.S. stocks, would be subject to withholding taxes in this type of account. This is not refundable to Canadian tax payers. RESP Similar to the TFSA, money going into an RESP is tax-paid, personal money and there are no tax liabilities on any form of income earned in an RESP. Foreign dividends may also be subject to withholding taxes, which are not refundable. When money is withdrawn from the RESP, taxes are payable by the beneficiary of the RESP. Should however the beneficiary(s) not use the full amount of money in the RESP, the money is fully taxable upon withdrawal by the contributor (or it may be rolled over into their RRSP under special circumstances). PERSONAL HOLDING COMPANY (PHC) THOUGH IT APPEARS THAT INVESTMENTS HELD WITHIN A PHC WILL BE SUBJECT TO HIGHER TAX RATES THAN A PERSONAL ACCOUNT, THERE ARE WAYS TO DIVIDE MONEY IN THE PHC TO RECAPTURE SOME OF THE TAXES PAID By referring strictly to the tax table in this article, it would appear investments held within a PHC will be subject to higher tax rates than a personal account. While this is true, there are ways to distribute money from the PHC to the shareholder(s) and recapture some of the taxes paid. This would result in a lower net tax rate, which could effectively drop to as low as 25%. As a general rule, if shareholders of a PHC are planning on dividending out all or a portion of the investments, returns earned in the PHC, generating Canadian dividends and capital gains would provide the greatest tax efficiencies. MCLEAN & PARTNERS WEALTH MANAGEMENT 4

5 FAMILY TRUST TO AVOID PUNITIVE TAXES IN A FAMILY TRUST, FLUSH OUT ANY INCOME TO THE BENEFICIARIES OF THE TRUST ON AN ANNUAL BASIS Investments held within a family trust will be subject to the same tax consequences as a personal account, albeit at the highest marginal tax rate. The way you avoid these potentially punitive taxes would be to allocate any income (interest, dividends, capital gains) to any/all of the beneficiaries of the trust on an annual basis. This way the income received by the beneficiary will be taxed at their own marginal tax rate(s) on the amount and type of income received. Other Considerations Owning U.S. stocks directly in any of the abovementioned structures will leave you subject to the new Canadian and U.S. reporting requirements. In addition, based on your U.S. real property ownership amounts (including U.S. stocks and real estate), you may be subject to U.S. estate taxes. Ownership of private controlled Canadian corporations may offer substantial tax advantages. You should explore the benefits of the types of structures which are best suited for these investments by your tax advisor. Finally, income splitting opportunities may exist which could help reduce your overall tax liabilities. Again, this should be discussed with your tax advisor. MCLEAN & PARTNERS WEALTH MANAGEMENT 5

6 Graham Thiessen Graham commenced his articles with a national accounting firm before qualifying as a chartered accountant in In 2008, he joined an accounting firm in the Cayman Islands where he worked primarily with hedge funds and insurance captives. In 2012, Graham moved to Calgary to become a partner in a small accounting firm where he worked with small to mid-sized companies. Graham joined the Leadership Group as Partner at Buchanan Barry LLP in Graham has served private and not-for-profit companies for over eight years, providing advisory, assurance, accounting and tax services. His primary focus is working with owner-managed businesses Founded in 1960, Buchanan Barry LLP is an established presence in the Calgary business community. We offer audit and assurance, accounting, tax, valuation and advisory services to large and small enterprises, non-profit organizations and individuals. Tel. (403) McLean & Partners Wealth Management McLean & Partners Wealth Management Ltd. provides investment advisory services to high net worth individuals, trusts, and notfor-profit organizations. The firm manages portfolios through both segregated accounts and pooled investment vehicles. While we invest in public equity and fixed income markets across the globe, our primary focus is to invest in dividend producing growth stocks. Tel. (403) The views and opinions expressed herein are those of the author and do not necessarily represent those of McLean &Partners Wealth Management Ltd. The information contained in this report has been obtained from sources believed to be reliable, however, we cannot represent that it is accurate or complete. A subsidiary of Canadian Western Bank, McLean & Partners provides independent research and advice to its clients on a fee-for-service basis. The company is not engaged in any investment banking, underwriting, consulting or financial services activities on behalf of any companies. McLean & Partners research reports are for the sole purpose of managing client portfolios on a managed and non-managed basis. The company may engage in proprietary trading to invest surplus corporate cash balances. The opinions expressed herein are those of the author and do not necessarily represent those of McLean & Partners Wealth Management Ltd. The information obtained in this report has been obtained from sources believed to be reliable, however, we cannot represent that it is accurate or complete. McLean & Partners Wealth Management Ltd. is a member of the Canadian Investor Protection Fund and the Investment Industry Regulatory Organization of Canada. MCLEAN & PARTNERS WEALTH MANAGEMENT 6

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