Some basics of Canadian Investing; Mutual Funds, Eligible Dividends and Deferred Tax

Here is a brief introduction to the absolute basics of investing Canada. If you know this, you really just know the basics.  If you do not know much about Mutual funds, Eligible dividends, income trusts, and deferring taxes owing then trust me, this is the tip of the iceberg.  The Investment Fund Institute of Canada (IFIC) has a mutual fund course as probably does the Canadian Securities Institute (CSI).  Both are sought after for entry into the financial sector.

At the very basic, here are the 2 main types of tax-sheltered investments you probably have heard about - RRSP or RRIF.  In both cases, you put money away into these investments which are NOT taxed at year-end.  you pay taxes when you withdraw or remove the funds after certain milestones, such as age 65. 

Investments that generate capital gains or Canadian source dividends are taxed more favourable than interest income because interest income earned from investments such as T-Bills, bonds, and GIC’s are generally taxed at the highest marginal tax rate.
• Dividends earned from a Canadian Corporation are taxed at a lower rate than interest income.  This is because dividends are eligible for a dividend tax credit, which recognizes that the corporation has already paid tax on the income that is being distributed to shareholders.
o This only applies to dividends from a Canadian corporation.
o Dividends paid from a foreign corporation are not eligible for the dividend tax credit.

As of 2006 there are now two types of dividends, eligible and non-eligible dividends, and they are treated differently from a tax perspective.
• Eligible dividends include those received from a public Canadian corporation and certain private, resident corporations that must pay Canadian tax at the general corporation rate. As a result, they have a federal tax credit of 18.97% and are grossed up by 145%.
• Non-eligible dividends include those received from Canadian-controlled private corporations not subject to the general corporate tax rate.  They have federal tax credit of 13.33% and are grossed up by 125%.

This change was introduced by the government of Canada in order to present a more balanced tax treatment between corporations and income trusts as Canadians were investing more and more in income trusts and less and less in corporations and why wouldn’t they, since prior to 2006 income trusts were not taxed on any income allocated to unit holders, whereas dividends paid by a Canadian corporation are paid out of after tax earnings. 

To combat this, many corporations began to restructure their operations to become income trusts.  Something had to be done.

In a typical income trust structure, the income paid to an income trust by the operating entity may take the form of interest, royalty or lease payments, which are normally deductible in computing the operating entity’s income for tax purposes.  These deductions reduce the operating entity’s tax to nil.   

The trust ”flows” all of its income received from the operating entity out to unitholders.  The distributions paid or payable to unitholders reduces a trust’s taxable income, so the net result is that a trust would also pay little to no income tax, which is never a good thing in the government’s eyes.

So who then gets hit with the tax bill??  The net effect is that the interest, royalty or lease payments are taxed at the unitholder level;
1. A flow-through entity whose income is redirected to unitholders, the trust structure avoids any possible double taxation that comes from combining corporate (T2) income taxation with shareholders’ dividend taxation
2. Where there is no double taxation, there can be the advantage of deferring the payment of tax.  When the distributions are received by a non-taxed entity, like a pension fund, all the tax due on corporate earnings is deferred until the eventual receipt of pension income by participants of the pension fund.
3. Where the distributions are received by foreigners, the tax applied to the distributions may be at a lower rate determined by tax treaties, that had not considered the forfeiture of tax at the corporate level.
4. The effective tax an income trust owner could pay on earnings could actually be increased because trusts typically distribute all of their cashflow as distributions, rather than employing leverage and other tax management techniques to reduce effective corporate tax rates.  It’s easier to distribute all the funds out and show nothing being retained that it is to implement strategies to reduce corporate tax owing which is the path most often taken. 

Where can a holder find their dividends reports?  Dividends are usually shown on the following CRA slips:
• T5, Statement of Investment Income
• T4PS, Statement of Employees Profit Sharing Plan Allocations and Payments
• T3, Statement of Trust Income Allocations and Designations
• T5013, Statement of Partnership Income
• T5013A, Statement of Partnership Income for Tax Shelters and Renounced Resource Expenses

When completing a Canadian tax return, where should a holder enter their dividend information?

Enter on Line 180 the taxable amount of dividends (other than eligible dividends) as follows:
• box 11 on T5 slips
• box 25 on T4PS slips
• box 32 on T3 slips
• box 51-1 on your T5013 or T5013A slips.

Enter on Line 120 the taxable amount of all dividends from taxable Canadian corporations, as follows:
• boxes 11 and 25 on T5 slips
• boxes 25 and 31 on T4PS slips
• boxes 32 and 50 on T3 slips
• boxes 51-1 and 52-1 on your T5013 or T5013A slips.

What do I do if I did not receive an information slips?

Ignore it and the CRA will let me off the hook?  No chance.  If you did not receive an information slip, you must calculate the taxable amount of other than eligible dividends by multiplying the actual amount of dividends (other than eligible) you received by 125% and reporting the result on line 180.  You must also calculate the taxable amount of eligible dividends by multiplying the actual amount of eligible dividends you received by 141%. Report the combined total of eligible and other than eligible dividends on line 120.

So what exactly is a capital gain?

Capital gains occur when you sell an asset for more than you paid for it. This gain is offset by any losses and can be further reduced by any expenses that are incurred by the purchase or sale of the asset – resulting in net capital gain.
Taxation of capital gains: 50% of a net gain is taxable at the appropriate federal and provincial rates.

My accountant advised me I need more “Tax deferral”.  What does she mean?   She means contributing the maximum amount to your RRSP which provides an immediate tax deduction and tax sheltered growth as long as the investment(s) remain in the plan.

Other less commonly used strategies include:
• Universal Life Insurance is a policy that combines life insurance coverage with a tax deferred investment component. Premiums paid are first used to ensure life coverage and the balance accumulates in an investment account where it grows tax deferred.
• Registered Educations Savings Plan (RESP) is a plan where contributions are used to fund a child or grandchild’s post secondary education costs.
o initial contributions are not tax-deductible
o any income earned within the plan is only taxable in the hands of the student at the time of withdrawal.

More is coming in the next few days, weeks and months…

Related articles

• What tax slips / returns did I receive and why? (intaxicating.wordpress.com)
• Thursday Thirteen – Taxation Related (urbandaddy.wordpress.com)

The two certainties in life… Death and Taxes.

This post is a brief look at estate filing rewuirements with the Canada Revenue Agency (CRA) and the role and requirements of an executor in Canada.

In Canada, there is no estate or succession tax, unless you consider the taxes owing to the CRA on the estate at death.  RC4111(E) for English is what I used to do my research on this area, which can be tricky if you have no experience dealing with Estates, or with the CRA; http://www.cra-arc.gc.ca/E/pub/tg/rc4111/rc4111-e.html.

Here is what makes it complicated… Your loved one dies and there is money left in the estate and by money, I’m referring to bank accounts, some investments and maybe an asset owned in the name of the deceased, like a car, or even a house.  Before you, or the person responsible (the executor) can begin removing things from the deceased’s name into someone else’s name – usually yours - they have to first go to the CRA and find out if the deceased owed any taxes. 

Aside from information already on their systems, the CRA will know if there are taxes owing by the deceased based on what has already been filed.  But what about stuff not filed yet?  One way the CRA determines if there are any taxes owing is by having the executor complete the filing of all tax returns owing for the deceased within 60-90 days of their date of death.  Then, if there is no amount owing, the CRA provides a certificate called a clearance certificate which the executor can then present to banks, etc along with the death certificate in order to move funds and investments over to the surviving member.

If a clearance certificate is not received and funds are disbursed and the estate owes taxes, the CRA can then hold the executor liable for those funds!

The returns the CRA will be looking for include a T1 (individual tax return) for the decreased covering the period from January 1st of the year of death up to the date of death, reporting all income from employment and investments.  Report income earned after the date of death on a T3 Trust Income Tax and Information Return.  A T3 reports income from trusts for the estate (all the assets of the deceased make up the estate).

The capital gains (profit on any item bought) on their investments also have to be accounted for an added on this return.

If you file the final return late and there is a balance owing, the CRA will charge a late filing penalty (LFP).  They will also charge interest on both the balance owing and any penalty. The penalty is 5% of any balance owing, plus 1% of the balance owing for each full month that the return is late, to a maximum of 12 months – as of January 2012.  The LFP may be higher if the CRA has charged a LFP on a return for any of the three previous years.

In certain situations, the CRA may cancel the penalty and interest if you file the return late because of circumstances beyond your control.  If this happens, complete Form RC4288, Request for Taxpayer Relief, or include a letter with the return explaining why you filed the return late. For more information, go to Fairness and Taxpayer Bill of Rights or see IC07-1, Taxpayer Relief Provisions.

Here is the 2011 CRA guide for preparing returns for deceased people;

http://www.cra-arc.gc.ca/E/pub/tg/t4011/t4011-e.html

What tax slips / returns did I receive and why?

Have you ever received tax slips in the mail and wondered why?

Here are some of the slips you may have received and a description of what they are reporting:

 

RRSP Contribution Receipts

RRSP contribution receipts are issued for all contributions, regardless of the amount, and show all reportable contributions for the tax year.   These get mailed more frequently if you are actively contributing to your RRSP,  with the first mailing at the end of January (for contributions made between March 1st and December 31st), and in separate mailings until mid-March (for contributions made in the first 60 days of the following year, to be applied to the previous year. 

 

T4RSP/T4RIF Relevé 2 (RL2)

T4RSPs/T4RIFs are issued for all withdrawals, regardless of amount, and show actual or deemed withdrawals from an RRSP/RRIF, including Lifelong Learning Plan (LLP), Homebuyers Plan, marriage breakdown and hardship. Quebec residents must file the RL2, in addition to the T4RSP/T4RIF.   These slips are mailed by the last day in February, so you should be receiving them around then, early March at the latest. 

 

NR4

NR4s are only issued for amounts of at least $50 per currency for investment accounts, but for any amount for registered accounts. NR4s are also issued for amounts less than $50 per currency if tax was withheld from the payment. It records reportable income from Canadian sources for non-residents of Canada.  The NR4 is required to be mailed before the last day in March (or early April if March 31st falls on a Saturday or Sunday). 

 

T4A/Relevé 1 (RL1)

T4As are issued for all withdrawals, regardless of amount, and show actual or deemed withdrawals from an RESP. Quebec residents must file the RL1, in addition to the T4A.   T4A’s / RL1′s are required to be mailed by the last day in February. 

 

T5/Relevé 3 (RL-3)

T5′s report dividend and interest income and are only issued for amounts of at least $50 per currency. It consists of two parts: the T5 Supplementary (which shows the reportable regular and split share income for the tax year) and the Investment Income and Expense Summary (which provides details of the totals, including expense items). Quebec residents must file the provincial tax form, Relevé 3, in addition to the T5.   These are mailed out to holders before the last day in February.

 

T3/Relevé 16 (RL16)

T3′s report trust and mutual fund income and are only issued for amounts of at least $100. It consists of two parts: the T3 Supplementary (which shows the reportable capital gains and other income for the tax year) and Summary of Trust Income and Expense (which provides details of the totals, including expense items, as well as the adjusted cost base portion – return of capital). Quebec residents must file a RL16, in addition to the T3.  These are to be mailed before the last day in March. 

 

T5013/ Relevé 15 (RL15)

T5013s are issued for limited partnership income, regardless of the amount, and record the partnership’s gain or losses at the partnership’s year-end. Quebec residents must file the RL15, in addition to the T5013.   These are sent out before the end of March.

 

Relevé 7 (RL7)

RL7′s are issued for Quebec Residents only, recording all reportable income from the Small and Medium Enterprises Growth Stock Plan (SME), formerly called the Quebec Stock Savings Plan.  These are mailed before the last day of February. 

 

1099-DIV

1099-DIVs show all reportable dividends paid to a U.S. person (or individuals subject to US tax laws) during the tax year.   1099-DIV’s can be mailed out by the end of January, however, the IRS allows for companies to file for 30 day extensions, and most apply for it to be sure of no penalty or interest, so these forms are mailed by the end of February instead.  

 

1099-INT

1099-INTs show all reportable interest paid to a US person (or individuals subject to US tax laws) during the tax year. These are to be mailed by the end of January.

 

1099-B

1099-Bs show all reportable distributions for a US person (or individuals subject to US tax laws) during the tax year.  As mentioned with the 1099-DIV’s are subject to an extension and thus are usually mailed by the end of February instead of the end of January. 

 

1042-S

1042-S’s show all reportable US source income paid to a non-resident of the US during the tax year.  These forms are to be mailed by the end of March. 

Related articles

• What is a 1099-MISC? (bargaineering.com)

CRA Snitch Line

CRA Snitch Line 1.866.809.6841.

Even go into a store and get charged tax, but the teller never runs it through the cash register?   They do it because they’re keeping the extra tax for themselves. Call the snitch line.  Or, you go to buy something and they only accept cash… Be wary.

Does your neighbour brag about how much money he makes under the table and lives way better than you do?  Call the snitch line.

Does your ex-spouse not want to file their tax returns because it would mean they would have to increase child support payments?!? Then call the snitch line.

This line is a direct link into the CRA Audit department and they use these “tips” to recover funds from professional tax avoiders.

Key words the CRA likes to hear includes;

Their names, their address, an amount of unreported income greater than, say $50K, maybe a second set of books, or 2nd property in the name of their cat…

It never hurts to call.

It always hurts to not call.

This line is anonymous and believe it or not, the majority of “tips” come from exes who are left holding the bag while their ex-spouses are living it up.

I figured I would post this since it is the most frequently asked question I get.  Yes a line exists and yes it gets acted on… and fast if the dollar amount to be recovered is high.

 

New CRA Non-Resident Forms starting January 1st, 2012.

Well, look how time flies!

The new CRA Non-resident treaty-rate requirements take effect on January 1st, 2012.

Non-residents of Canada who are eligible for benefits under a tax treaty entered into between Canada and another country will now have to complete a declaration or provide equivalent information to avail themselves of any reduced rate of tax or exemption provided under the relevant tax treaty instead of relying on their domicile.

The Canada Revenue Agency (CRA) recently released three declaration forms to be used by non-residents of Canada for this purpose, namely;

Form NR301 – Declaration of eligibility for benefits under a tax treaty for a non-resident taxpayer.
http://www.cra-arc.gc.ca/E/pbg/tf/nr301/nr301-10e.pdf

Form NR302 – Declaration of eligibility for benefits under a tax treaty for a partnership with non-resident partners
http://www.cra-arc.gc.ca/E/pbg/tf/nr302/nr302-10e.pdf

Form NR303 – Declaration of eligibility for benefits under a tax treaty for a hybrid entity.
http://www.cra-arc.gc.ca/E/pbg/tf/nr303/nr303-10e.pdf

What information is the CRA now looking for?

Non-residents of Canada must disclose on these forms the following information:
(i) Legal name of non-resident
(ii) Mailing address of non-resident
(iii) Confirmation of type of non-resident (i.e., individual, corporation or trust)
(iv) Foreign and Canadian tax identification numbers if any
(v) Country of residence for treaty purposes
(vi) Type of income for which the non-resident is eligible for treaty benefits (e.g., interest, dividends, royalties, trust income, income from business carried on in Canada or gains from disposition of taxable Canadian property).

Where does the form go?

The non-resident must immediately notify the payer of any such income, or partnership or hybrid entity through which the income is derived, so they can be given the treaty rate.

Does this form expire?

Yes, These forms expire on the earlier of any change in the non-resident’s eligibility for treaty benefits or three years from the end of the calendar year in which this form is signed and dated.

What onus is now on the payor?

For its part, a Canadian resident payer is instructed NOT to apply a reduced Canadian withholding tax rate under Part XIII where:
(i) The non-resident has not provided the Form or equivalent information and such payer is not sure if the reduced rate applies,
(ii) The Form is not complete
(iii) A tax treaty is not in effect between Canada and the non-resident’s country of residence; or
(iv) Such payer has reason to believe that the information provided in the non-resident’s declaration is incorrect of misleading.

Who is liable?

If the non-resident does not complete the form and the treaty rate is given, the payor is held liable by the CRA for the difference between the treaty rate and the non-treaty rate, so usually 10%.

Big changes!

How are you preparing for them?

Canadian Taxation Back to Basics: What is a T3 return?

Often times with all the complexities that come with International taxation we sometimes lose sight of the basic questions that come our way in the taxation industry.

For example, what is a T3?

A T3 slip is a Canadian tax form that reports income from trusts for a tax year.

An individual taxpayer will include the amounts reported on the T3 on his personal tax return.

A corporation will include it as part of its investment income.

A trust (or trustee / intermediary / transfer agent, etc.) is required to provide the T3 slip to investors by the last day of February in the following year.

So what again is a T3 slip?

A T3 slip details the various types of income distributed from the trust for a taxation year.

Why would an individual get a T3 slip?

The most common reason is for distributions or dividend reinvestments in mutual funds or segregated funds.  However, if these funds are held in tax-deferred retirement (RRSP) or education accounts (RESP), no T3 will be generated.  The reason no slips is issued in those cases is because the income in those types of funds is reportable for tax purposes once they are withdrawn from the fund. 

The trust is responsible for filing copies of all T3 slips along with a T3 Return to Canada Revenue Agency (CRA) by the end of February in the following year.

What kinds of income can trusts distribute?

Trusts can distribute interest, royalties, business income, pension income and most commonly dividends and capital gains. 

Each is recorded on a separate line on the T3 slip.  Each type of income is treated differently for tax purposes and appears in a separate location on the taxpayer’s personal income tax return.  Capital gains may be offset by other capital losses in the year or from prior years.

Filing a T3

A T3 is filed as part of a taxpayer’s T1 personal tax return.

When is a T3 required?

Regardless of the fiscal year-end of the trust, the T3 is generated and reported in the year the income is received.

CRA releases New Forms for Treaty-Reduced Rates of Canadian Withholding Tax

The Canada Revenue Agency (CRA) recently released final versions of new forms, NR301, NR302 and NR303 which is to be provided by recipients of payments from Canadian residents to certify eligibility for treaty-reduced rates of Canadian withholding tax.

These Forms are not to be provided to the CRA, but rather to the Canadian resident payer of the withholdable amount or to certain intermediaries along a chain of payments subject to withholding.

Until recently, the CRA generally accepted reliance on the payee’s address for determining whether to apply a treaty rate. By releasing these forms, it signals that the CRA is requiring a greater level of diligence on the part of payers of withholdable amounts to be as sure as possible that the correct reduced treaty rate is applied.

Although the use of the Forms is not mandatory, and they will not guarantee avoidance of penalties, interest, or liabilities for underwithheld tax, many taxpayers will likely apply a 25% withholding rate on payments of withholdable amounts to recipients who do not complete the Forms.

The CRA is looking at the payor, to review the information provided by a non-resident on these forms, or in another format, and to make sure they have enough information to support that the non-resident is eligible for tax convention/treaty benefits on the income being paid.

In cases of inconstencies, the CRA is looking for intermediaries, prior to establishing a withholding tax rate, to question the information given and look at other information received from the non-resident, or known about the non-resident, if the payer knows or has reasonable cause to believe that the information on the form:
• is not correct or is misleading;
• contradicts information in the payer’s files; or
• is given without knowledge or consideration of the facts of a situation.

Forms are valid for the earlier of 2 years, or a change in the eligibility for convention benefits.

* Completing Form 301 is not mandatory. However, if a non-resident refuses to provide certification of beneficial ownership, residency, or eligibility for treaty benefits on request by a payer, the full statutory rate should be withheld.

One question that came up after the release of these forms was that they do not address holding global securities through CDS or DTC.

For some direction, you need to check the update to IC76-12, “Applicable Rate of Part XIII Tax on Amounts Paid or Credited to Persons in Countries with Which Canada Has a Tax Convention” related to Forms NR301, NR302, and NR303.

In this update, the CRA states that payments made to CDS on securities registered in the name of Cede & Co. (the nominee name for DTC) are made without tax. Tax will be withheld by CDS based on information received from DTC and collected by DTC’s participants.

I recommend you read the news release below to familiarize yourself with these forms.

The link to the release follows; http://www.cra-arc.gc.ca/formspubs/frms/nr301-2-3-eng.html

Here are the forms;

Form NR301, Declaration of eligibility for benefits under a tax treaty for a non-resident taxpayer; http://www.cra-arc.gc.ca/E/pbg/tf/nr301/nr301-10e.pdf

Form NR302, Declaration of eligibility for benefits under a tax treaty for a partnership with non-resident partners; http://www.cra-arc.gc.ca/E/pbg/tf/nr302/nr302-10e.pdf

Form NR303, Declaration of eligibility for benefits under a tax treaty for a hybrid entity; http://www.cra-arc.gc.ca/E/pbg/tf/nr303/nr303-10e.pdf

Garron Decision Upheld by Tax Court of Canada

December 2nd, 2010.

The Tax Court of Canada (TCC) decision in Garron, now known as St. Michael Trust Corp., was upheld in a recent Federal Court of Appeal (FCA) decision that serves as a warning that residency issues for trusts — and for corporations — should be taken seriously.

The decision concerned the residency of two trusts, and held that similar considerations should apply as are required to determine the residency of a corporation.

The FCA agreed with the TCC’s determination that the trusts at issue were resident in Canada and not Barbados since, among other reasons, the trusts’ real decision makers were their beneficiaries, who were Canadian residents. Therefore, the capital gains realized by the trusts were taxable and not treaty exempt. There is also a lengthy discussion in obiter of other issues in the event the trusts were resident in Barbados, including the application of section 94 of the Income Tax Act, the application of the Canada-Barbados Tax Treaty to exempt the gains and the application of the General Anti-Avoidance Rule (GAAR).

Had residency in Barbados been successfully established for the trusts, the tax planning would have been successful, i.e., the gains would have been exempt under the treaty and the GAAR would not have applied.

Withholding, Roth IRA’s and Part XIII

Last week I was approached by a CEO of a very large US Corporation who was questioning the need to have withholding tax taken off his dividend payment, when the funds were earmarked for his Roth IRA.

From pervious communication on this matter I knew there should be no withholding, but I wanted something more concrete to put on my website in order to have for nay future queries and to educate all of you who look for an answer.

So I called the CRA international office and they confirmed that the dividend paid to U.S. holder who registered in Individual Retirement Accounts (“IRAs) are not subject to Part XIII (non-resident withholding) tax.

Also they advised me that there is no specific document regarding IRAs provided on CRA website.

Please see below statement from Canada – U.S income tax convention:

http://www.fin.gc.ca/treaties-conventions/USA_1-eng.asp

ARTICLE 13
3. For the purposes of this Convention:
(a) The term “pensions” includes any payment under a superannuation, pension or other retirement arrangement, Armed Forces retirement pay, war veterans pensions and allowances and amounts paid under a sickness, accident or disability plan, but does not include payments under an income-averaging annuity contract or, except for the purposes of Article XIX (Government Service), any benefit referred to in paragraph 5; and
(b) The term “pensions” also includes a Roth IRA, within the meaning of section 408A of the Internal Revenue Code, or a plan or arrangement created pursuant to legislation enacted by a Contracting State after September 21, 2007 that the competent authorities have agreed is similar thereto. Notwithstanding the provisions of the preceding sentence, from such time that contributions have been made to the Roth IRA or similar plan or arrangement, by or for the benefit of a resident of the other Contracting State (other than rollover contributions from a Roth IRA or similar plan or arrangement described in the previous sentence that is a pension within the meaning of this subparagraph), to the extent of accretions from such time, such Roth IRA or similar plan or arrangement shall cease to be considered a pension for purposes of the provisions of this Article.

Now you know!

More on the T5008

The purpose of the T5008 information slip is to report the amount paid or credited to an investor for securities disposed of or redeemed during the year.

Firms that issue T5008 slips generally report only the “proceeds of disposition” (box 21) and not the “cost or book value” (box 20) on the slips since the cost is often either not known or tracked by many brokerage firms. Therefore the onus is on the investor — perhaps with your assistance — to track their own tax cost or adjusted cost base of the securities held, in order to accurately report the capital gain or loss on his or her tax return.