Archive for October, 2016

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Year-End Tax Secrets: Mutual Funds

Mutual funds are common investments but can often cause some tax confusion, particularly because investors don’t understand their real returns from these investments, after fees and taxes.

Here’s the year-end tax secret: In some cases, there are unintended results that can push investors into a higher tax bracket than expected at the end of a tax year and make quarterly instalment remittances, and often interest payments for under-remitting, necessary.

This is because mutual fund companies are required to distribute all interest, dividends, other income and net capital gains to their unit holders at least once every year at their fiscal year end. With the exception of any return of capital, these distributions are taxable.

Mutual fund trusts have a fiscal year end of December 31. Income for the full year will be distributed at the end of the calendar year. This is true, even if you invested late in the year. Therefore, investors may wish to hold over making the investment to the new year.

Mutual fund corporations, on the other hand, may choose a fiscal year other than the calendar year end. This means that income distributions could occur at any time in the year. Best to invest shortly after the distributions are made to avoid the tax. In addition, the cost of the units tends to decrease when the dispositions are made.

In addition, it’s noteworthy that rarely is this income received in cash. Rather, the income is used to buy more units in the fund and those reinvested amounts are added to the Adjusted Cost Base. This makes the reporting of sales or deemed dispositions of mutual funds a more difficult undertaking at tax time, because you will need to have kept track of your ACB. Most mutual fund companies can help you with this; however, it’s a good idea to track this on a spreadsheet to ensure the ultimate reporting of capital gains or losses on disposition is correct.

Don’t forget, switches between classes in a mutual fund become taxable after December 31, 2016. It is likely a good idea to review risk tolerance and investment objectives against this change in tax reporting rules, which will speed up the taxes that would otherwise be deferred until disposition. Consider whether the balancing of the investment portfolio before the year end can better manage outcomes.

Year-end tax planning involves a solid review of asset allocation strategies as well as net and taxable income levels to ensure that investment decisions in a non-registered account achieve the right results. This includes a review of marginal tax rates and potential clawbacks of tax credits or OAS. Speak to a DFA-Tax Services Specialist for assistance if required, before year end.


CPP Actuarial Report: Expected Return 3.9% to 2090

The 27th Actuarial Report on the Canada Pension Plan provides some fascinating reading about Canada’s demographics and economy over the next 75 years, to 2090.

The average annual real rate of return on the fund is expected to be 3.9% in that period, and the report reassures that the current legislated contribution rate of 9.9% will be “more than sufficient” to cover expenditures to 2020, with up to 26% of investment income making up the difference between CPP contributions and expenses by 2056.

Under the current 9.9% contribution rate, this means contributions will grow from $47 Billion to $66 Billion in 2025. Assets in the plan, meanwhile, will accumulate to 6.5 times annual expenditures by 2025: $476 Billion. These assets are projected to grow rapidly in the near term to 2020. A slow pace of growth is projected out to the year 2050, but by 2078 the ratio of assets to the following year’s expenses is expected to be roughly the same as it is now.

The report notes that the number of contributors to the plan will grow from 13.8 million in 2018 to about 15 million in 2025. And so, despite an increase in the number of beneficiaries receiving benefits (from just over 5 million in 2016 to 10.2 million in 2050), the plan will be able to meet its obligations throughout the projection period.

In the meantime, the current government’s recent push to sweeten the pensions of Canadians by increasing CPP premiums as soon as 2019 has not been taken into account here. This will need to be factored into the next report.

The goal under the much-heralded reform proposals, is to replace one-third of the taxpayer’s pensionable earnings up to a maximum of $82,700[1] , which is a 14% increase in the upper earnings level over inflation adjustments. Under current rules, the CPP replaces 25% of pensionable earnings up to a maximum of $51,400 ($54,900 less a basic exemption of $3500). Currently, the required premium, the employer and employee each paying half, is calculated at a combined rate of 9.9% (4.95% each).

The proposed new premium calculation is complicated:

  • In addition to the regular CPP contribution rate on lower earnings, both the employer and the employee will pay a separate contribution rate of 4% on those top pensionable earnings.
  • A new 1% premium will be phased in over five years, starting in 2019, increasing the lower premium rate to 5.95% by 2023.
  • By the year 2025, the annual combined (employee/employer) contribution for taxpayers earning the maximum pensionable earnings of $82,700 will be calculated at a rate of 10.9% for pensionable earnings under $72,500 and 4% for incomes above that, up to $82,700.
  • This results in a total contribution of $9,027 ($8,211 plus $816), $4,513.50 paid by the employee and $4,513.50 by the employer).
  • That’s an increase of 77% over 2016 levels. Regular inflation increases would have accounted for $1,742 of that increase, so the changes add an additional $2,196 or 43% to the premiums payable annually in today’s dollars.

It’s a long period of prepayment for future retirees’ pensions. Under the proposed changes, CPP premiums will become much more expensive soon, with the increased pension benefits resulting from those changes not taking full effect until 40 years after the changes to premiums take effect—in 2065.


 

[1] 2025 levels after inflation and proposed increase. A basic exemption will be applied to this figure.


Beef Up Your 2017 Canada Child Benefit Now

It’s unclear whether Canadians are really getting more from their Canada Child Benefit in 2016 over the Universal Child Care Benefit and family income splitting. That’s the subject of our October poll. However, at this time of the year there is lots a tax specialist can do to make sure your family maximizes the credit.

Here’s how the Canada Child Benefit works: First, it’s a refundable credit based on family net income. Specifically, the new Canada Child Benefit provides a maximum benefit of $6400 per child under the age of 6, and $5400 per child age 6 to 17.

But it’s income tested. That means we have to watch the clawback zones and stay under them. Problem is, that’s complicated:

Family Net Income
Number of Children Under $30,000 $30,000 to $65,000 Over $65,000
1 0% 7.0%* $2,450 + 3.2%**
2 0% 13.5% $4,725 + 5.7%
3 0% 19.0% $6,650 + 8.0%
4+ 0% 23.0% $8,050 + 9.5%

* % of income over $30,000    **% of income over $65,000

How much you ultimately get in the benefit year July 2017 to June 2018 will depend on your family net income in 2016. You’ll have to file a tax return and make sure the number on Line 236 is as low as possible. Here are the types of provisions that will help you get more from the CCB:

  1. An RRSP contribution
  2. Professional or union dues
  3. Child care expenses
  4. Moving expenses
  5. Employment expenses
  6. Carrying charges on your investments

You can see that RRSP planning for families is extremely important as clawback zones can bring marginal tax rates over 50% for taxpayers with income under $65,000.  Here’s what we mean:

Example: RRSP Contribution to Increase CTB


Bruce and Joan have four children, all under age 6.  Joan stays at home and Bruce’s net income is $60,000.  The family’s Canada Child Benefit for the year is $18,700.  His tax bill is $8,946.  If Bruce were to make an RRSP contribution of $5,000, his net income would be reduced to $55,000 which would, in turn, increase his Canada Child Benefit to $19,850 and his tax bill would be reduced to $7,463.  The family gets an additional $1,150 CCB and saves $1,483 in taxes.  By making an RRSP contribution of $5,000 the family’s wealth increases by $2,633.  That means the cost of not making that RRSP contribution is $2,633 or 52.66% of the contribution.


To receive the CTB, you must be either a Canadian citizen, an Indian, a permanent resident, a refugee (protected individual), or a temporary resident who has lived in Canada for at least 18 months (and is legally allowed to continue to live here).

Currently, individuals may apply for CCTB and UCCB as far back as to the introduction of programs.  However, other income-tax based credits are subject to a 10-year limitation.  After 2016, retroactive application of UCCB and CCB will also be subject to the 10-year limitation. (In fact, that’s year-end tax planning tip to be aware of in general – be sure to recover any missed tax credits or deductions within the 10-year window.)

Unfortunately, there is no non-refundable tax credit for minor children for those who do not qualify for the income-tested benefits. This was removed when the previous government introduced the Universal Child Care Benefit enhancements and the Family Tax Cut, both of which have since disappeared.

Other non-refundable tax credits will soon be removed as well: the education/textbook amounts are eliminated, as is the refundable children’s fitness credit, starting in 2017.

Check out these family tax changes with your tax specialist now, to see their real dollar effects on your family budget.

 


New Tax Reporting Rules Will Affect All Homeowners

A broad-based change by the Department of Finance, announced on October 3, 2016, will provide an excellent opportunity for collaboration before year end by financial advisors, accountants and their clients who have sold a principal residence in 2016.

Finance Canada has proposed that all real estate dispositions must be reported on the tax return starting in 2016, even if the property qualified as a principal residence in every year of ownership. Prior to 2016, no reporting was required at all when a taxpayer disposed of a property in such cases. A full exemption for the gain was considered to have occurred under the principal residence rules.

Taxpayers will have to report that disposition on their T1 tax returns on Schedule 3, effective for any dispositions on or after January 1, 2016 according to CRA. (This is different from the October 3 date mentioned by Finance Canada in their announcement.) Actual, deemed and mixed-use dispositions are all affected. Financial advisors will want to brush up on those various transactions and their tax consequences.

Further, CRA will be given the authority to assess taxpayers beyond the normal assessment period (currently 3 years) regarding real estate transactions. The proposals did not give a limit to the extent of the new reassessment period. The opportunity for the CRA is to assess whether the principal residence should be tax exempt or whether, frequent flips of the home or failure to inhabit the home appropriately will amount to a taxable disposition.

Worse, CRA will be given the power to levy penalties of up to $8000 for late designation of their real estate as a principal residence.

At this time, new forms have yet to be drafted but early information indicates that year of acquisition, proceeds of disposition, and description of the property will be required.

Trusts are affected, too. They will be restricted from claiming the principal residence exemption for tax years after 2016 unless certain additional eligibility criteria are met. Qualifying trusts will include a spousal or common law partner trust, an alter ego or similar trust, a qualifying disability trust or a trust for the benefit of a minor child of deceased parents. The beneficiary of the trust must be a resident of Canada in the year the property is inhabited, and a family member of the person who creates the trust. Grandfathering criteria will be set in place.

In addition, new rules were introduced to prohibit permanent non-residents who acquired a home in Canada after October 2, 2016 from claiming the principal residence exemption.

These new changes will be discussed in detail at Knowledge Bureau’s Distinguished Advisor Workshops, being held in Vancouver on October 27, Winnipeg on November 1, Toronto on November 2 and Calgary on November 3. To register call 1-866-953-4769.

Advisors can add significant value to year end tax planning conversations with this important new information and alert their clients to potentially expensive CRA headaches for failure to comply.