Education finance goes back to school

The continuing case for RESPs

It’s back-to-school time, bringing with it both excitement and anxiety as children and their parents return to their routines.

But when it comes to saving for higher education, this year is arguably anything but routine. Familiar education supports have been eliminated as part of the introduction of the Canada Child Benefit (CCB), and the latest release of tuition data shows the steady continuing rise in the cost of post-secondary education.

It’s a reminder that parents need a long-term plan for how they will pay for their children’s education. In turn, it should reinforce the value proposition offered by registered education savings plans (RESPs) and matching Canada education savings grants (CESGs).

CCB and education supports

From last year’s election campaign through to this year’s federal budget, most of the media coverage of the CCB has focused on what it’s replacing: the Canada Child Tax Benefit, National Child Benefit supplement and Universal Child Care Benefit. (For a more detailed rundown on the CCB generally, see our blog post “What does the Canada Child Benefit mean for parents?”)

As well, the family tax cut has been eliminated, and the children’s fitness and arts credits are halved for 2016 and eliminated thereafter.

On the education front specifically, the tuition tax credit remains, but the education tax credit and textbook tax credit are eliminated after 2016. For full-time students, those credits are respectively worth $400 and $65 for each month a student is in school. For example, the value for a student in school eight months in a year would be: [$465 x 8] = $3,720 x 15% credit rate = $558.

If a student does not use the entire education, textbook and tuition credits to reduce his/her tax owing, any remaining amount may be transferred to a parent, grandparent or spouse. After 2016, this will only apply to the tuition credit, but the cap on the transferrable amount will continue to be $5,000.

As part of the CCB package, Canada Student Grants are to increase by 50%, from $2,000 to $3,000 per year for students from low-income families and from $800 to $1,200 per year for students from middle-income families. Those income thresholds depend on number of children and province. Currently for a one-child family, low income is about $20,000 to $25,000, and middle income ranges from $38,000 to $48,000.

Tuition costs on a steady rise

Each September, Statistics Canada releases the results of its annual survey of tuition and living accommodation for colleges and universities. The average tuition for a full-time undergraduate student in 2016/17 is $6,373, 2.8% higher than the 2015/2016 average of $6,201. This is a weighted average by students in each program. Strip out the higher costs of dentistry, medicine, law and pharmacy and the range is between $4,580 and $7,825.

Beyond the absolute numbers and the current-year change, the most instructive part of the survey is the long-term trend. Looking back across the 11 years available in the data series, the average cost of tuition has risen almost 4% annually on average, for a cumulative rise of 45%.

Table: Rising cost of post-secondary education

Figures are also tracked for compulsory school fees (admission fees, student association fees, athletic levies, etc.), which have similarly risen by about 4% annually, from $608 in 2004 to $873 in 2016.

If these trends continue, a child born in 2006 who begins post-secondary education at age 18 in 2024 will face first-year tuition and additional compulsory fees in excess of $9,700, almost double what it would have been at birth. And this does not include accommodation, transportation or groceries – let alone discretionary expenses.

Saving for education using RESPs

In law, the Latin phrase res ipsa loquitur means “the facts speak for themselves.” In making the case for the need to save prudently for a child’s future education, it is reasonable to say that these numbers speak volumes.

It is clear that funding a child’s education has become more costly and more complicated. Those who lost out in the CCB changes will foot more of the ever-inflating bill personally, and those who gained must understand that the greater amount they are getting in those early years is intended in part to help them save for later.

The three key features of RESPs should figure prominently in all plans:

  • Investment returns grow tax-sheltered
  • Matching 20% CESGs accelerate those investment returns
  • Income and grants can be taxed to an attending student on withdrawal

More information is available in our “Registered Education Savings Plan” InfoPage and our quick-reference InfoCard.

Applying a multiple will strategy for probate reduction and privacy

At issue

While we most often speak of a person’s last will and testament in the singular, the practice of using multiple wills has a long history.  There are a number of reasons why a testator might want to have more than one will, most commonly:

  • Reducing probate tax in jurisdictions where that is a material concern,
  • Protecting the privacy of the deceased and beneficiaries by shielding against potential disclosure of the nature and value of assets in public/court documents and processes, and
  • Providing for less costly, more timely and generally less complicated procedures for dealing with real estate outside the deceased’s home jurisdiction.

In a purely domestic arrangement, the usual process is for the lawyer to concurrently prepare a primary will that deals with the estate generally, and a secondary will that carves out certain assets.  This secondary will is often called the ‘non-probate’ will, assuming probate reduction is a prime motivation.  Though probate is a small percentage cost to an estate, where multi-million dollar assets such as private corporation shares are involved, the absolute dollar cost can be substantial. 

Where foreign real estate is added to the mix, things can be even more challenging.  Coordination is not only required among documents, but also from one lawyer’s office to another.  

Clearly, informed intentions and coordinated professional advice are critical to reaping the benefits of this sophisticated strategy.

Granovsky Estate v. Ontario, 156 DLR (4th) 557

Heard in 1998, this case involved a carefully executed dual will strategy isolating $25 million of private corporation shares in a secondary will.  The Ontario government sought to add the shares to the $3 million in the primary will for calculation of the probate fee (now known as estate administration tax).  This would increase the probate fee by $375,000 (in 1995 dollars).

Ontario Estates Act section 53(1) required that probate fees were to be paid “upon the value of the whole estate, including the real estate as well as the personal estate.” [emphasis added]  However, section 32(3) allowed for a limited grant of probate allowing an applicant to “set forth in the statement of value only the property and value thereof intended to be affected by such application or grant.” [again, emphasis added]

The court considered multiple wills cases as far back as the late 1800’s, reviewed the evolution of the current statutory provisions, and even marked the origin of probate fees in 1358.  Those fees originally applied only to personal property, not real estate.  

With respect to the Ontario legislation, the judge noted that “[it] was later added as real property within the jurisdiction, and this would account for the “whole of the estate” in s. 53 of the Act.”  So while s.53 extends the probatable estate to include real estate, s.32(3) allows a testator to select which assets will be governed by a given will, including using a secondary will for assets that do not require probate. 

McLaughlin v. McLaughlin, 2014 ONSC 3162, 2014 ONSC 5046, 2015 ONSC 3491, 2015 ONSC 4230, 2016 ONSC 481

In an effort to reduce probate/estate administration tax, a testator’s secondary will purported to deal with one parcel of real estate separate from other assets.  Unfortunately there were some clerical drafting errors that duplicated bequests from the primary will, and there was no residue clause.

The case serves as a lesson as to the need for carefully coordinated drafting.  As well, it illustrates how longstanding family conflict (over 20 years in this case) can carry through to estate turmoil, with the family returning to court five times, though in fairness two of those dates were to address costs rulings.  

Practice points

  1. Granovsky enables the use of multiple wills to reduce probate (estate administration tax) in Ontario, and it has been followed in some provinces.  However, some provinces specifically disallow the strategy, so a qualified lawyer should be consulted.
  2. Bear in mind that establishing the strategy and keeping it up-to-date requires some cost and effort.  The documents must be drafted such that they do not revoke one another, and so that no conflicting double-dealing arises.  
  3. As well, the wider the variety of assets referred to in the documents and the more frequent those change, the greater the cost of re-drafting and the possibility that something may fall between the cracks. 

New 33% tax bracket effect on passive income in private corporations

No doubt there was disappointment in the business quarter when the 2016 Federal Budget held the small business corporate tax rate at 10.5%. It was scheduled to decline by half points to reach 9% in 2019. Taking an optimistic view, this may only be a reflective pause, given that the Liberal government had earlier stated its intention to reduce the rate to that level. We shall see.

The news is even less rosy for those same business owners when considering the implications of the new 33% top bracket tax rate that was ushered in with the “middle class tax cut.” Not only will this new rate apply to personal income over $200,000, it also affects passive income inside their corporations. And the impact could be most costly to the smallest of those small business owners if they fail to adjust how they manage their corporate investments.

Corporate-personal tax integration

The proper functioning of our tax system is based in part on the integration of personal and corporate taxes. Absent such a coordinated approach, the use of a private corporation – especially a Canadian-controlled private corporation (CCPC) that uses the small business tax rate – could lead to unintended tax benefits or unfair tax costs.

Integration is carried out using a number of mechanisms at the corporate level and on passing income from corporation to individual as shareholder. Business owners would have some familiarity with integration when they think of the following two-stage process of how their dividends are taxed:

  • The grossed-up dividend is the amount used to calculate the shareholder’s initial tax due as if he or she had earned the income out of which the corporation paid the dividend
  • This initial amount is reduced by the dividend tax credit (representing the tax revenue the Canada Revenue Agency (CRA) already collected from the corporation) to arrive at the shareholder’s net tax bill

Tax system’s response to passive corporate income

While the gross-up/tax-credit process applies on a dividend distribution from corporation to individual, there remains the matter of how to deal with undistributed income.

When that income is reinvested to generate more business income, there is no problem from a tax policy perspective. Indeed, one of the main purposes of the small business rate (which is actually in the form of a deduction from the general corporate rate) is to enable greater reinvestment and business growth than would otherwise be the case if a higher tax rate applied, whether the business was run as a sole proprietorship or through a corporation.

But where excess corporate cash is not going back into operations and instead placed into portfolio investments, a problem arises. As only the corporate portion of the ultimate tax bill has yet been paid, more cash is being passively invested than would be possible in the shareholder’s hands. As the small business rate is intended as a business booster and not a portfolio bonus, the tax system’s answer is to impose a tax cost that emulates the corporation as a top-bracket personal taxpayer. In a sense, it is the reverse of the gross-up on dividends, but in a much more complex way.

Integration mechanisms, 2016 and beyond

Not only is a CCPC not entitled to use the small business deduction on its investment income, but it also faces an additional tax on that income, specifically the Part I refundable tax. This is tracked in the corporation’s tax records as refundable dividend tax on hand (RDTOH), a portion of which is refunded from the CRA to the corporation when taxable dividends are paid to shareholders. However, Canada-sourced dividends are subject to a different rate as Part IV tax, all of which is refundable. On the other hand, foreign dividends are given a reduced RDTOH credit.

Suffice it to say, there are a lot of moving parts, the full details of which are beyond the scope of this brief article. As to the changes, the increase in the top personal tax rate from 29% to 33% necessitates adjustments to these integration mechanisms, the clearest illustration being the four-percentage-point increase in the Part I refundable tax. The rest of the changes are produced here for reference, without getting into the underlying calculations.

Taken together, the changes make it a bit more punitive to earn investment income in a CCPC beginning in 2016. A shareholder whose personal income tax bracket is below $200,000 should take particular note, and perhaps consider adjusting how and when income is taken out of a corporation. And for all affected corporations, a closer look at the tax efficiency of investment choices in corporate accounts may be in order, to explore if and how exposure to RDTOH may be mitigated.

TABLE: Corporate-personal integration mechanisms