Tag: Deduction

Five tax drivers of RRSPs

Taking full advantage of registered plan features

A registered retirement savings plan (RRSP) helps you save towards retirement in a tax-effective way. Through five key features, an RRSP encourages you to save, lets you defer tax so you can accumulate more, and paves the way for you to ultimately reduce tax on your retirement income.

1.    Tax-deductible contributions

For every dollar you place into an RRSP, you can take a deduction against your income.

In a sense you are declining to receive that income in the current year, in favour of taking it as income some time later. Though that income is yours to keep, you are setting it aside in an RRSP where it can be invested until you draw on it, generally meaning your retirement.

There are limits to how much deduction can be taken, based on historical income and past contributions, but it’s the mechanics of the procedure we’re focused on presently.

2.    Investing pre-tax dollars

Had you not made an RRSP contribution, you would have been taxed on that amount. That would have left you with less money to be invested in your hands directly as compared what you have available in your RRSP. Put another way, you are investing pre-tax dollars as opposed to after-tax dollars.

We’ll discuss the tax applying on RRSP withdrawals below, but for now the result is that there is more available to earn investment income.

3.    Tax-sheltered earnings and growth

With the benefit of those larger pre-tax dollars, the next step in using an RRSP is to start investing your money. As those investments grow and earn income, there is no tax to be paid, or as is commonly stated, an RRSP is ‘tax-sheltered’.

Some people prefer the term ‘tax-deferred’, given that eventual withdrawals are taxable, as we’ll cover in a moment. Until withdrawal though, there is more to be reinvested, which leads into the next feature – compounding.

4.    Tax-efficient reinvestment and compounding

Just as using pre-tax money gives you more to start with, reinvesting tax-sheltered income can accelerate your growth. This is obviously helpful at first instance, and gets even better over time through the effect of compounding.

Initially only your own principal is being invested, but as you earn income then that income is invested, which generates income-on-income. Year after year, this repeated reinvestment is responsible for an increasing portion of your returns, in time possibly exceeding what you earn on your own contributions.

This compounding effect is not at all exclusive to RRSPs, but it will be accentuated in an RRSP where the full amount of all earnings can be put to work without being reduced by taxes. 

5.    Tax deferral until withdrawal, likely at lower tax bracket

The features covered to this point have helped you build your investments with the benefit of tax deferral on both contributions and earnings. Now on withdrawal, tax is due. Even so, you will pay less tax by using an RRSP, assuming your tax rate is lower on withdrawal in your later years than it was on contribution in your working years when you contributed.

But what if you are early in your career at a fairly low-income level? Most people will make the RRSP contribution and claim the deduction. That’s a smart savings habit, but you can also be strategic with the taxes. Instead of taking the deduction that same year, you can carry it forward to claim in a year when you’re at a higher tax bracket, making the deduction worth more.

Your financial advisor can help you decide whether deferring the deduction makes sense for you, and how you can take best advantage of all the tax features of RRSPs.

Advertising on social media – Deduction complication … and simplification

At issue

We are about two decades into the commercial internet age. Alongside the expanding list of never-before-seen online goods and services, traditional bricks-and-mortar businesses are simultaneously being transformed by this digital revolution. The lines have blurred in terms of physical production, as have geographic and regulatory borders.

When it comes to taxes, some may find it appealing (possibly amusing) to see our authorities playing catch-up, but that means uncertainty for entrepreneurs. To make viable financial plans, businesses need to know whether and how existing rules will map over into their digital activities, or if they have entirely new compliance requirements to contend with.

Early on much of the focus was simply on what is subject to tax, and as new offerings emerge those determinations continue. Equally important is the question of what may be deducted from that income, to which the Canada Revenue Agency has recently provided some clarity in the area of advertising on social media.

Income Tax Act (ITA) Canada – Deductions generally

The general ability to take a tax deduction is expressed first as a denial, followed an exception:

18 (1) In computing the income of a taxpayer from a business or property no deduction shall be made in respect of (a) an outlay or expense except to the extent that it was made or incurred by the taxpayer for the purpose of gaining or producing income from the business or property [my emphasis obviously]

Of course, numerous provisions constrain the application of that general exception. Some of those are overarching such as the reasonableness requirement in s. 67. Others are more targeted, in particular for our purposes the sections dealing with advertising.

ITA – Limitation on advertising expense

The advertising limitations are expressed in s.19 for newspapers (including any “comics supplement”), s.19.01 for periodicals, and s.19.1 for a broadcasting undertaking.

Much of these rules address cross-border issues: from the citizenship of the publisher; to the degree to which editorial activity occurs in Canada; to the geographic location of typesetting or physical printing; to the proportion of editorial-to-advertising space, and more. Depending on the resolution of these issues, advertising may be fully deductible, half-deductible, or not at all – and in some cases a reference to the Department of Canadian Heritage may be called for.

It requires a great deal of interpretation to apply that language and those concepts in a dynamic new media industry, not to mention the due diligence burden placed upon the taxpayer to ascertain the necessary information to work with. In fact, it would not be unreasonable to characterize that traditional framework as antiquated, and in many ways unmanageable.

CRA letters 2017-0708891M4 (August 2017) and 2017-0719471E5 (September 2017)

In August 2017, the Minister of National Revenue Diane Lebouthillier personally responded to a taxpayer inquiry sent to a Member of Parliament. The question was whether foreign online advertising was deductible. The Minister acknowledged the general s.18 deductibility and the constraints of ss. 19, 19.01, and 19.1. She then advised, as head of the CRA, that those limiting rules would not be applied to the deductibility of advertising expenses on foreign Internet websites.

Another letter was issued by the CRA in September 2017, responding to a similar issue. The question was about the treatment of advertising on social media. The agency confirmed that the Canadian content and ownership rules would not apply to social media sites or networks, including foreign websites.

Practice points
  1. Expenses are generally deductible if an outlay is incurred to generate income from a business or from property, and it is reasonable in the circumstances.
  2. There are rules that limit deductibility of advertising expenses, contingent on whether certain Canadian content or Canadian ownership requirements have been met.
  3. The CRA has confirmed that Canadian content / foreign rules will not apply to advertising on social media networks or foreign websites.

Investment fees paid from outside RRSP, RRIF or TFSA – CRA position deferred to 2019

At issue

A common feature among RRSPs, RRIFs and TFSAs is that investments accumulate on a tax-sheltered basis. In principle, any reduction in the amount in the respective account reduces the benefit of that tax sheltering. Where investment management fees are paid from an external source, more money remains invested in the particular account.

However, whether an investor is inevitably better-off should take into consideration the source of those external funds. Whereas RRSP and RRIF accounts are pre-tax, a TFSA is after-tax. Arguably, using after-tax money from a cash account for a pre-tax RRSP/RRIF fees may not be the best result for an investor. The benefit is clearer with TFSAs, as both it and a cash account hold after-tax funds. Investors should consider their own tax position before coming to a conclusion.

Apart from the investor’s decision, the Canada Revenue Agency (CRA) has been mulling over the issue. According to its most recent communication, their updated and more stringent position will not apply until 2019, and hopefully we’ll have more clarity on that position early in the coming new year.

Income Tax Act s. 207.01(1) (b)(i)

These “advantage rules” were enacted in 2007 with the introduction of TFSAs, and were extended to RRSPs and RRIFs in 2011.

The definition of “advantage” applies to an increase in the value of a registered plan because of an action or transaction of a non-arm’s length party to the plan. If someone at arm’s length party would not have taken the action, and if the purpose is to benefit from the plan’s tax-exempt status, then a 100% tax applies to the amount of the determined advantage.

2016-0670801C6 – 2016 CTF Q5. Investment management fees for RRSPs, RRIFs and TFSAs

The CRA has a long-standing administrative policy that it does not consider it to be an over-contribution if a planholder uses outside funds to pay registered plan expenses. At the 2006 Canadian Tax Foundation Conference, the CRA was asked whether it holds a similar deferential view on the application of the (relatively new) advantage rules.

In response, CRA stated that an increase in value of the registered plan indirectly results from investment fees being paid by a party outside of the plan. This would likely be an advantage, and the planholder could personally be subject to advantage tax of 100% of the amount of fees paid.

The agency then advised that it was continuing its review of fees and fee rebates and would share the results in an Income Tax Folio expected to be published in early 2017. Its revised position would apply to fee payments after January 1, 2018.

2017-0722391E5 – Investment management fees

In September 2017, the CRA announced that it was considering a number of submissions from various stakeholders, and would be deferring the proposed implementation date by one year to January 1, 2019.

It made no mention of an updated target date for publication of the relevant Tax Folio, nor did it give any indication that it might be reconsidering its position.

Practice points
  1. Expect publication of the Income Tax Folio on the advantage rules in 2018. As the CRA’s original advisory acknowledged that time would be needed for the investment industry to make applicable system changes, presumably CRA is still targeting for a date early in the year.
  2. There will be no negative tax consequences for the payment of investment fees for registered accounts from any source any earlier than 2019.
  3. Apart from the CRA/tax rules, individual investors should consider their own tax situation before deciding the appropriate source for the payment of investment fees.