NexGen Tax Cases The Corporate Tax Deferral and Income Program

2014 NexGen Tax Cases The Corporate Tax Deferral and Income Program Business owners and managers in Canada who have incorporated have two major income tax advantages available to them over those who have not incorporated. Tax Deferral the ability to delay tax bills into the future, and Income Splitting the ability to distribute income to family members in a highly tax efficient manner. These strategies require both planning and forethought, but by simply acquiring an understanding of the basic concepts enclosed within this booklet you will be one step closer to putting them into action and developing a Corporate Tax Deferral and Income Program. www.nexgenfinancial.ca

NexGen Tax Cases NexGen Tax Managed Funds: A Comprehensive Corporate Class Mutual Fund Structure Created in 2006, NexGen Funds allow investors to make two independent choices with each investment. These are: 1 An Investment Decision: Considering goals and personal risk tolerance, select the appropriate Tax Managed Fund. NexGen Funds (CASH, BOND, BALANCED, EQUITY) 2 A Tax Decision: Considering the individual tax preferences and future needs for income, select the appropriate Tax Class. 4 Tax Classes: CAPITAL GAINS MONTHLY DIVIDEND MONTHLY ROC DISTRIBUTION COMPOUND GROWTH Money invested in NexGen s Funds and Tax Classes may be reallocated within the NexGen Tax Managed Fund family at anytime without triggering any current tax liability. This flexibility allows an investor to continually customize both their investment and tax situation in pursuit of his/her investment goals as well as tax minimization. Using NexGen s unique investment and tax structure, investors are able to finally control Tax Alpha and provide tax efficient growth and withdrawals.

The Corporate Tax Deferral and Income Program The owner-manager in Canada who has incorporated his/her business has two major income tax advantages available over those who have not incorporated: Tax Deferral and Income Splitting. I The Tax Deferred Advantage Active business income (the net income derived from the primary activity of the business) is taxed in a Canadian Controlled Private Corporations (CCPC) at a much lower rate than if this income was earned directly by the owner manager. Small Business (up to $500,000) Personal (highest marginal tax rate) Difference British Columbia 13.50% 45.80% 32.30% Alberta 14.00% 39.00% 25.00% Ontario 15.50% 49.53% 34.03% Quebec 19.00% 49.97% 30.97% Newfoundland 15.00% 42.30% 27.30% Northwest Territories 15.00% 43.05% 28.05% This difference is only temporary and the advantage is lost once the money is removed and placed in the hands of the individual shareholders. Therefore, for those fortunate enough to earn more in their CCPC s than they require for annual personal expenses, it makes sense to hold these extra dollars in the corporation and invest for the long term in the name of the CCPC. Annual cash flow requirements (for personal use) are best planned by your accountant. They will decide the most tax efficient method (salary needs versus dividends needs) to accomplish these withdrawals keeping in mind such matters as Canada Pension Plan and Registered Retirement Saving Plan contributions. Once the decision to invest within the corporation is made, there is definitely a right and a wrong way to proceed for the long term. Tax Alpha (the value that can be added by investing tax efficiently) is of paramount importance in determining the long term success of these corporately held investments. Distributing taxable income annually when there is no current need for cash flow creates current tax liabilities within the CCPC which reduces the amount available for future compounding. The tax rates on this passive income are punitive and extremely high (ranging from 44 to 49% depending on the province of residence) and this should be avoided.

NexGen Tax Cases The Corporate Tax Deferral and Income Program COMPOUND GROWTH As an example, assume a CCPC has $1,000,000 of investable after tax dollars and these will not be needed for 10 years. Let s look at two alternatives each earning 5% annually with the first distributing this income annually as interest and the second deferring all growth until liquidation and then to be taxed as a capital gain. Just to be certain we are comparing similar results lets also assume that all after corporate tax dollars are then withdrawn from the CCPC and taxed in the hands of the shareholders at the highest marginal tax rates. Although this last step is rarely done, the example can demonstrate the potential of income splitting as set out below.* Over 10 Years Tax Inefficient Interest Tax Efficient Using Deferral Deferral Advantage over Interest Invested Capital $1,000,000 $1,000,000 $0 Total Growth $565,117 $628,895 $63,778 Total Corporate Income Tax Paid $260,914 $0 $260,914 Corporate Fair Market Value After Tax $1,304,203 $1,628,895 $324,692 Personal Income Tax at Liquidation $323,150 $469,461 $146,311 Net Income After Tax $981,053 $1,159,434 $178,381 FMV in Corporation by Year Liquidation of Assets at the End of the Year $2,000,000 $1,200,000 $1,500,000 $1,100,000 $1,000,000 $1,000,000 $500,000 $900,000 $0 1 2 3 4 Tax Efficient 5 6 7 8 Tax Inefficient using Interest 9 10 $800,000 Tax Efficient 10 Tax Inefficient using Interest The impact of managing Tax Alpha in corporate investment planning is significant. If managed properly these dollars can grow to significant levels (often the largest asset pool in the hands of the owner-manager) and can become a significant portion of the owner-manager s retirement cash flow requirements. We call this The Corporate Tax Deferral and Income Program. * Uses 2013 Corporate and Personal income tax rates for Ontario. As you can clearly see, certain income types are far more tax advantageous than others.

MONTHLY DIVIDEND CAPITAL GAINS I Income Splitting The second advantage of being incorporated is the ability to control the timing and frequency of distributions and to split income among your family to save tax dollars. With the help of accountants and lawyers, a share structure can be put in place which allows for the legal income splitting of withdrawals from the corporation amongst your family member shareholders. This share structure still allows the owner-manager to be in control of all decision making including how much and to which shareholders. Due to our graduated rate income tax system, income splitting allows you to reduce the total tax liability on withdrawals from the CCPC as opposed to having income taxed solely in the hands of the owner-manager. However, here too, it is important to manage distributions in the right way. For example, let s assume we grow $1,000 of investment income in the CCPC and distribute these dollars to a shareholder of our choice who is a resident of the province indicated. The following shows the after corporate and personal tax result to that shareholder who is in the highest marginal tax bracket. (using 2013 tax rates) Interest Eligible Dividends Capital Gains British Columbia $502 $751 $713 Alberta $575 $807 $788 Ontario $482 $662 $741 Quebec $482 $648 $741 Newfoundland $538 $775 $769 Northwest Territories $544 $772 $772 I SOLUTIONS In order to facilitate a Corporate Tax Deferral and Income Program NexGen offers a number of solutions that can be used in conjunction with NexGen Tax Managed Funds. NexGen s Compound Growth Class objective is to maximize the after-tax value of an investor s portfolio by minimizing the amount and frequency of distributions. This Tax Class objective supports the tax deferral strategy laid out in this booklet. NexGen s Dividend Tax Credit Class and it s Capital Gains Class are both designed to provide sources of income, when available, of Canadian eligible dividends (monthly) and capital gains (annually), respectively. These Tax Classes can support the income splitting strategy explained in this booklet by providing tax efficient distributions to your corporation s shareholders.

Personal Tax Rates Federal and Provincial Combined* Other Income Capital Gains Canadian Dividends Eligible Dividends Small Business Dividends Tax Free Eligible Dividends** ($) British Columbia *** 45.80% 22.90% 28.68% 37.98% 49,285 Alberta 39.00% 19.50% 19.29% 29.87% 49,285 Ontario **** 49.53% 24.76% 33.82% 40.13% 49,285 Quebec 49.97% 24.98% 35.22% 39.78% 35,080 Newfoundland 42.30% 21.15% 22.47% 31.01% 49,285 Northwest Territories 43.05% 21.53% 22.81% 32.40% 49,285 * Highest marginal tax bracket only in excess of $136,270 in taxable income Basic non-refundable tax credit only. ** No other income, Basic non-refundable tax credit only. May attract Alternative minimum tax. *** British Columbia established an Ultra High Tax Bracket above $150,000. From $136,270 to $150,000 Other Income 43.70%; Capital Gains 21.85%; Eligible Dividends 25.78%; Small Business Dividends 35.51%. **** As of July 1, 2012, Ontario established an Ultra High Tax Bracket above $500,000 ($514,090 in 2014). From $136,270 to $514,090 Other Income 46.41%, Capital Gains 23.20%, Eligible Dividends 29.52%, Small Business Dividends 36.45%. Old Age Security and the Clawback Old Age Security qualification is based on legal Residency in Canada. The payout begins once the individual achieves the age of 65 and the maximum is paid after 40 years of residency after the age of 17. A minimum pro-rated payment is payable after 10 years of residency. Old Age Security is Clawback in any year when the recipient s net income for tax purposes (line 234) exceeds a threshold amount. In 2014, that threshold amount is $71,953 and every dollar above that level see a clawback of 15 cents of the OAS. The entire amount is clawbacked once net income for tax purposes exceeds approximately $115,670. The OAS is adjusted quarterly to reflect the cost of living index. See the NexGen Tax Case booklet for strategies to reduce or eliminate the Clawback. Sources: www.taxtips.ca www.kpmg.com/ca

Corporate Tax Rates Federal and Provincial Combined, Canadian Controlled Private Corporation Small Business Income up to $500,000 General Active Passive Investment Income Taxed Deferred Advantage*** British Columbia 13.50% 26.00% 45.67% 32.30% Alberta 14.00% 25.00% 44.67% 25.00% Ontario 15.50% 26.50% 46.17% 34.03% Quebec 19.00% 26.90% 46.67% 30.97% Newfoundland 15.00% 29.00% 48.67% 27.30% Northwest Territories 15.00% 26.50% 46.17% 28.05% *** Personal tax rate (HMTR) less corporate tax rate on Small Business Income. Sources: www.taxtips.ca www.kpmg.com/ca

Invest Better : Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the prospectus before investing. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated. Mutual fund securities are not covered by the Canada Deposit Insurance Corporation or by any other government deposit insurer. The payment of distributions for Dividend Tax Credit Class and the Return of Capital Class should not be confused with a mutual fund s performance, rate of return or yield. If distributions paid by a mutual fund are greater than the performance of the fund, then your investment will decline. Distributions paid as a result of capital gains realized by a mutual fund and income and dividends earned by a fund are taxable in your hands in the year they are paid. For Return of Capital Class, your adjusted cost base will be reduced by the amount of any returns of capital. If your adjusted cost base goes below zero, then you will have to pay capital gains tax on the amount below zero. Tax liabilities on investment income and capital gains earned by a mutual fund cannot be mitigated nor can they be fully managed in all circumstances. The risk increases the greater the investment return earned by the mutual fund. As a result, a mutual fund may be required to make taxable distributions to investors in a NexGen Tax Class for which a distribution or type of distribution is not optimal or in accordance with their tax preference. The tax efficiency of the Return of Capital Class and the Compound Growth Class is enhanced the greater the demand for the Capital Gains Class, Dividend Tax Credit Class and the Registered Fund Class. Use of Tax Cases : These cases have been established by NexGen. The contents and information contained in the Tax Cases are for informational and educational purposes only and should not be construed as legal, tax or investment advice. Information contained within this cases is believed to be accurate and reliable at the date of creation, however, NexGen cannot guarantee that such information is complete or accurate or that it will remain current. The information is subject to change without notice and NexGen cannot be held liable for the use of or reliance upon the information contained in the NexGen Tax Cases. The rates of return, annual distribution rates and income components comprising a given distribution contained in the tax cases and reflected in certain graphs and tables are for illustrative purposes only utilizing various assumptions to demonstrate the importance of compound growth and the effects of taxation on a given investment. They are not intended to reflect, nor should they be interpreted, as an indication of future values or returns on investment in respect of any NexGen Fund. www.nexgenfinancial.ca NexGen Financial Limited Partnership 36 Toronto Street, Suite 1070 Toronto, Ontario M5C 2C5 Ph 866 378 7119 Fax 866 378 7121 Ph 416 775 3727 Fax 416 775 3737 1-02-2014