Whether you’re inclined to say, “It’s not about the income, it’s about the outcome,” or maybe, “It’s not how you make out, it’s what you take out,” tax is the difference between the top line and the bottom line.
As 2008 comes to a close, here is a look back at the significant tax developments that have occurred over the last year or so.
Federal Budget 2007 – Holdovers
Pension splitting
Announced in last year’s Budget, pension splitting became a tangible reality in 2008 for pensioners preparing their 2007 tax returns. The rules allow for up to 50% of eligible pension income to be split over to the pensioner’s spouse.
Apart from potentially shifting income to a lower bracket taxpayer, related benefits may include reducing clawbacks on Old Age Security and the age 65 credit, and doubling up access to the pension credit if the receiving spouse does not already have his or her own eligible pension income.
While the change certainly provides relief for many seniors, there remains a sore spot: For pensioners under 65 to qualify, the income must originate from a registered pension plan (or via a pre-deceasing spouse’s RRSP, RRIF or DPSP). Indeed, in its submissions this past summer for the 2009 Federal Budget, the Investment Funds Institute of Canada suggested that pension splitting be allowed at age 55 for all registered plans. This would certainly level the playing field for those not having the benefit of a registered pension plan.
Whatever may happen, this is welcome development, and likely a standing feature of our tax system for the foreseeable future.
RDSPs
The Registered Disability Savings Plan was announced in the 2007 Budget, to be available for deposits beginning in 2008. These plans will allow for deposits of up to $200,000 to grow tax-sheltered for qualified disabled beneficiaries. As a further boost, deposits will be augmented by federal matching grants of up to 300% of deposits, as well as free bond money being available based on family net income.
Unfortunately, to date no plans have been able to be put in place as the financial service industry awaits necessary administrative details from the federal government. During an informational program attended by the writer in late spring, a representative from Human Resources and Social Development Canada (HRSDC) stated that those details will be delivered by December, 2008, so we may see plans made available by early 2009.
RRIF conversions
The end of 2008 will also see the end of the transitional period related to the move of the commencement of mandatory RRIF withdrawals from age 69 to age 71. In 2007 and 2008, these rules allowed for RRSP or RRIF re-contributions for certain age 70 and 71 individuals. In 2009, we will again simply need to be aware that those RRSP annuitants attaining age 71 in the calendar year must convert their RRSP to a RRIF, purchase an annuity or cash their RRSP.
Federal Budget 2008
TFSAs
By far the most significant development of the last year was the announcement of the new Tax-Free Savings Account. In this writer’s opinion, it is in fact the biggest change in how Canadians will manage money since the creation of the RRSP in 1957, and time may prove it out to be even bigger yet.
As stated in the Budget document, “This flexible, registered, general-purpose account will allow Canadians to watch their savings – including interest income, dividend payments and capital gains – grow tax-free.”
Beginning in 2009, each Canadian resident taxpayer age 18 or older will be entitled to place up to $5,000 annually into a TFSA account. This limit will be indexed annually, but will only increase when the resulting figure rounds up to the next $500 level. Unused contribution room may be carried forward indefinitely.
In contrast to the RRSP/RRIF regime where deposits are pre-tax and withdrawals are taxable, the TFSA receives after-tax funds and withdrawals are 100% tax-free. (Of course both types of plans allow tax-sheltered accumulation.) The additional benefit of the TFSA structure is that the non-taxable withdrawals have no effect on income tested tax credits, nor do they contribute to the clawback of Guaranteed Income Supplement or Old Age Security.
Interest is not deductible on money borrowed to contribute to a TFSA (like RRSP loans), but TFSA account value may be pledged as security for further borrowing.
From a spousal wealth and estate planning perspective, a high rate taxpayer may contribute into a spouse’s TFSA without being subject to the income attribution rules. Furthermore, at death (or at separation), a TFSA account may rollover to a spouse and remain tax-sheltered in the receiving spouse’s hands.
For many, the most surprising and valuable feature is that when a TFSA holder makes a withdrawal, there is a dollar-for-dollar recovery of contribution room for making future deposits.
RESP changes
Some of the time limits associated with RESPs have been extended to provide additional flexibility to students.
The time period for allowable contributions to a plan is extended from 21 to 31 years following the year in which the plan is entered into. Similarly, the termination date for a plan is extended from 25 to 35 years following the opening of the plan.
The government also relaxed the rules surrounding Educational Assistance Payments. Rather than requiring that the student be currently enrolled in order to obtain an EAP, an RESP beneficiary may receive EAPs for up to a six-month “grace period” after ceasing to be enrolled in a qualified program.
Unlocking Federal LIFs
Canadians who have funds “locked up” inside of federal Life Income Funds (LIFs) will now have greater access to their money beyond the current annual maximum withdrawal limits.
Small balance withdrawal – Individuals who are at least 55 years of age with LIFs worth less than $22,450 (to be indexed to the average industrial wage) will be able to wind up their accounts or convert them to another tax-deferred savings vehicle, such as an RRSP or RRIF, in which there are no maximum withdrawal limits.
Financial hardship withdrawal – Any LIF holder, regardless of age, facing “financial hardship” (low-income individuals or individuals with high disability or medical-related costs) can unlock up to $22,450 (also to be indexed).
One-time unlocking – Individuals who are at least 55 years of age may “unlock” up to 50% of their LIF holdings and transfer the funds into another tax-deferred savings vehicle, such as an RRSP or RRIF, in which there are no maximum withdrawal limits.
Interest deductibility – Lipson case
Being able to deduct interest charges on borrowed money is at the heart of both simple and complex tax-assisted investment leveraging. On April 23, 2008, the SCC heard arguments in the Lipson case, with the judgment expected imminently this fall.
As background, recall the Singleton decision of the Supreme Court of Canada from 2001. Mr. Singleton withdrew funds from his law partnership, used those funds to buy a house, mortgaged the house, then deposited the mortgaged funds back into the partnership. The SCC held that the mortgage interest was deductible as the use of the borrowed funds could be traced into a business or income-producing asset.
In Lipson, Jordanna Lipson borrowed money from a bank which she used to purchase some shares of the family investment company from her husband Earl. Earl used that money to buy a house, mortgaged the house, then used the mortgaged funds to pay off Jordanna’s loan. The government was successful at both the Tax Court of Canada and the Federal Court of Appeal, arguing that the interest deduction (and other tax benefits originally claimed) could not stand as the series of transactions offended the general anti-avoidance rule, or GAAR.
Tax practitioners are hopeful that the forthcoming decision will provide some clear principles from the top court to guide those engaged in leveraged investing. At time of writing, the SCC had not yet handed down its highly anticipated judgment.
Offside IPPs
In June, CRA issued Compliance Bulletin #5 re-confirming its intention to pursue and prosecute non-compliant registered pension plans, particularly offside individual pension plans. The bulletin recounts two successful prosecutions occurring at the Federal Court of Appeal in July, 2007: Jordan Financial and 1346687 Ontario.
Both cases involved a pre-retiree’s creation of a corporation and an associated pension plan to receive the value of a public service pension plan entitlement. The FCA found that neither was a true pension plan, resulting in deregistration and immediate taxation of the originally transferred amounts of $754,513.47 and $564,478.56, respectively.
The Bulletin lists further negative tax consequences that may result from deregistration, including interest and penalties. As well, notice is given that new applicants may be required to confirm the bona fides of a plan in writing prior to registration being granted. No doubt this is intended to both dissuade questionable structures and ease later prosecution.
RRSPs in bankruptcy
On July 7, the long awaited amendments to the federal Bankruptcy and Insolvency Act were proclaimed in force. The amendments give RRSP, RRIF and DPSP type plans the same protection that is afforded to registered pension plans in bankruptcy, with the exception that deposits made within a year of the bankruptcy will be available to creditors.
Prior to the amendments, a bankrupt with an RPP could carry it out of bankruptcy, but protection for RRSPs, RRIFs and DPSPs depended on the law of the province where the bankrupt was located. These amendments assure that there is a base level of consistency across the country, though stronger creditor protection may be available in some provinces, including the additional protection within insurance based plans where an appropriate beneficiary designation is in force.
Charities
Redeemer Foundation
On July 31, the Supreme Court of Canada issued its judgment in the Redeemer Foundation case. Redeemer was seeking judicial review to resist a CRA request to disclose donor lists. The SCC held that CRA may indeed use its audit powers to obtain a donor list, and further may use that list to identify and audit those donors.
ICAN
On August 9, CRA revoked the charitable status of International Charity Association Network. ICAN failed to provide adequate documentation for $464M of charitable receipts it issued in 2006. In its press release announcing the revocation, CRA stated that it is “reviewing all tax shelter-related donation arrangements, and it plans to audit every participating charity, promoter and investor.”
Snapshot – Current brackets and rates
Absent a further Fall Economic Statement by the incoming federal government or any of the provinces, the three exhibits below summarize the tax brackets and rates we will be using to report our taxes next April (or June if you run a business).
A few brief notes:
Whereas in 2007 we saw a mid-year downward adjustment of the lowest bracket from 15.5% to 15%, we end 2008 with the same federal rates that we began with
The graph format in Exhibit 2 provides a side-by-side visual comparison of how a taxpayer moves up through to top marginal rates, with as few as 6 brackets in Alberta and as many as 10 in BC, Ontario and Nova Scotia
Exhibit 3 shows that the top marginal rate on eligible dividends is below the rate on capital gains in four provinces in 2008, though those eligible dividend rates will generally rise through 2012 according to the federal schedule and provincial adjustments
Exhibit 1 – Federal tax brackets and rates – 2008
Basic amount to 9,600 0%
9,600 to 37,885 15%
37,885 to 75,769 22%
75,769 to 123,184 26%
123,184 to + 29%
Exhibit 2 – Combined federal/provincial tax brackets, 2008
[Graphic not rendered]
Exhibit 3 – Top marginal tax rates, 2008
Province Interest / foreign income Taxable capital gains Eligible/Ineligible dividends
British Columbia 43.7% 21.9% 18.5% / 31.6%
Alberta 39.0% 19.5% 16.0% / 26.5%
Saskatchewan 44.0% 22.0% 20.4% / 30.8%
Manitoba 46.4% 23.2% 23.8% / 37.4%
Ontario 46.4% 23.2% 24.0% / 31.3%
Quebec 48.2% 24.1% 29.7% / 36.4%
New Brunswick 47.0% 23.5% 23.2% / 35.4%
Nova Scotia 48.3% 24.1% 28.3% / 33.1%
Prince Edward Island 47.4% 23.7% 24.4% / 33.6%
Newfoundland & Labrador 45.0% 22.5% 28.1% / 33.3%