Canada Day: Flags, fireworks, tax planning
Tax-saving strategies for the COVID-19 crisis
A tried-and-true Canadian pastime is to seek out tax strategies that will let you cut your tax bill to the bone – legally. While it may not be a pastime ideally suited to Canada Day, why not save some of these ideas to discuss with your tax advisor at a future date when you can again focus on some serious tax planning? Triggering losses, crystallizing gains, and splitting income are just some of the opportunities you may be able to use.
I think it would be a safe bet to say that your investments might have taken a hit in the last few months. So you may want to consider cutting loose some of your losers. A loss triggered in 2020, can be carried back three years to offset any capital gains in previous years, or you can carry it forward indefinitely to offset future gains. Note: If you are lucky enough to have gains in 2020, you have to first use the losses against current year gains.
Beware of the superficial loss rules when triggering a loss. If you’re selling a security to take a loss, and you buy back an identical investment within 30 days before or after the sale, the Canada Revenue Agency (CRA) will deny the loss. Although these rules are designed to counter artificial losses, they could apply inadvertently – for example, if you sell, then change your mind and buy in again, maybe after the stock has dropped further.
The rules will also apply if your spouse (or a controlled company) buys back in within the 30-day period, but not if a child or parent reinvests. The rules apply not only to stocks but also to mutual funds. But they only apply if you repurchase an identical asset. So if you sell Bank A and buy Bank B, you’re okay.
When assessing whether you’re in a loss position, don’t forget that capital gains are calculated in Canadian dollars – so currency fluctuations can be a key consideration. If the Canadian dollar has appreciated against the currency the investment is denominated in, there will tend to be losses.
On the flip side, instead of triggering losses, you may want to also look at triggering a capital gain.
There has been much speculation about whether the CRA will increase the capital gains inclusion rate (currently at 50%) in the 2020 federal budget. Before COVID-19, the concern was due to the political climate (i.e., the Liberals had a minority government, and the NDP, on whom the Liberals rely to stay in power, had campaigned on increasing taxes). The 2020 budget was delayed with the onset of the pandemic. And now the speculation is that perhaps the government might increase the capital gains inclusion rate as a way to raise money to fund the various COVID-19 relief measures.
So if you anticipate a liquidity event in 2020, you may want to consider crystallizing your capital gain before the 2020 federal budget, just in case. And if you are not sure if there will be a liquidity event, consider a strategy that would put the pieces in place to trigger a gain, but still defer that decision until after the budget is released (you should reach out to your tax advisor to discuss possible strategies).
As to the timing of the federal budget, your guess is as good as mine. So you should have these discussions with your tax advisor sooner than later.
Capital dividend clean-up
If you hold your investments in a corporation, and are thinking of triggering losses as discussed above, then the first thing to do is to first check your corporation’s capital dividend account (CDA) balance.
What is a CDA? Well, as you know, only 50% of a capital gain is subject to tax. So when your corporation realizes a capital gain, it pays tax on (or a controlled company) 50% of the gain. The remaining “tax-free” 50% portion of the capital gain is added to the corporation’s CDA. A tax-free capital dividend can then be paid out of the corporation to you, the shareholder (as long as you are a Canadian resident). However, if the corporation realizes a capital loss as part of a loss-selling strategy, those losses will grind down the CDA balance, and you will lose the ability to take money out tax-free. So it is very important to make sure you clear out your CDA by declaring a tax-free capital dividend to yourself before you trigger any losses.
And if you don’t have any cash to pay the capital dividend, the corporation can satisfy the capital dividend with a demand promissory note, so you can always pull that amount out tax-free in the future.
The Income Tax Act is full of various rules to prevent you from trying to sprinkle income to low-tax family members (a strategy generally known as income splitting). The “attribution rules,” for example, would apply where you transfer property or funds to your spouse (including common law spouse), minor children, minor grandchildren, or minor nieces/nephews (that is, “family members”), unless you fall under certain exceptions.
But in down economies, these exceptions to the attribution rules generally get spotlighted.
One of these exceptions is the prescribed-rate loan strategy. You can avoid the attribution rules if you, the higher-income family member, lend funds to the low-income family members, provided that they pay you interest at the “prescribed rate” in effect at the time the loan is made.
Moreover, the interest on this loan has to be paid by no later than Jan. 30 each year. If you miss even one Jan. 30 deadline, the attribution rules will apply forevermore. The prescribed rate has been at 2% for the last little while, but it is going down to 1% on July 1 – so the opportunity to income split through a prescribed loan will become a lot more attractive.
If you don’t have cash to lend to your family member, consider doing a loan “in kind.” For example, if you have a securities portfolio in your name, transfer the portfolio to your low-income spouse and have your spouse issue a demand promissory note reflecting the prescribed interest rate for an amount equal to the fair market value of the portfolio at the time of the transfer. However, this transfer may be subject to capital gains tax by you, the transferor, as the transfer would have to be made at the portfolio’s fair market value. But if your portfolio has gone down in value, then now is time to make that transfer.
If you want to lend to any minor family members, you should do so through a family trust, as minors cannot legally borrow from you.
Defer RRSP contributions
If your income/salary has gone down this year as result of COVID19 lockdowns, you may want to consider deferring any RRSP contributions until next year, especially if you expect to be in a lower tax bracket for 2020. So hopefully, when you are back into the top bracket next year, you can double up your RRSP contributions for 2021.
Samantha Prasad, LL.B., is a Partner with Toronto law firm Minden Gross LLP, a Meritas Law Firm Worldwide affiliate, and specializes in corporate, estate, and international tax planning. She writes frequently on tax issues, and is the co-author of Tax and Family Business Succession Planning, 3rd Edition. She is also co-editor of various Wolters Kluwer Ltd. tax publications. This article first appeared in The TaxLetter, © 2020 by MPL Communications Ltd. Used with permission.
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The foregoing is for general information purposes only and is the opinion of the writer. This information is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting or tax advice.