Tax Planning for Difficult Economic Times
With the downturn in the economy, it is important to think about the impact
this will have on your tax situation. Doing so will ensure that the tax planning
and practices that you have used in the past are still relevant. It will also help
you determine whether there are specific tax planning ideas that you can use
to minimize or defer taxes. In this article, we identify key areas where planning
may be possible. It is important to note that the comments are very general in
nature, and you will need to work with your BDO advisor to implement any of the ideas discussed.
Tax Planning Ideas for Individuals
There are a number of ways individuals can reduce tax or defer tax.
Capital Loss Planning – With the recent declines in capital markets, investors
should review whether it makes sense to trigger capital losses. To the extent
that capital losses triggered in 2009 exceed capital gains realized in 2009, the
resulting net capital loss can be carried back to reduce capital gains that you realized in 2006, 2007 and 2008. Where it makes sense to trigger a capital loss
in 2009, you will need to keep in mind that our tax rules prevent taxpayers from
creating a capital loss where the investment is repurchased within 30 days
by the taxpayer or another affiliated person and on certain transfers. For
more information on these issues, please see “Tax Rules to Remember When
Triggering Capital Losses” in issue 2008-02 of The Tax Factor.
Interest Deductibility – Where you have borrowed to purchase investments,
remember that you can continue to deduct interest on the loan even if that
investment is sold for a loss. To maintain full interest deductibility, you must reinvest the proceeds you receive for the loss investment in a new investment
if the proceeds are not used to repay your investment loan. Note that different
rules apply for real estate and depreciable property.
Utilize Tax-Free Savings Accounts – Beginning on January 1, 2009, a new
investment option is available – the Tax-Free Savings Account or TFSA. This
option allows Canadian resident individuals who are 18 years of age or older to
set aside $5,000 a year (subject to indexing) and earn income that will not be
subject to tax. For more information, please see “Answering Your Questions on
the New Tax-Free Savings Account” in the 2008-02 edition of The Tax Factor.
Carefully Consider RRSP Contributions – Particularly for individuals in
the upper income tax brackets, RRSPs are a powerful tool to save for your
retirement. However, if cash is tight or your income may decline in 2009, then
you should carefully consider how much to contribute. Remember that if you
need to withdraw funds from your RRSP before retirement, the withdrawal will be taxed and the contribution room used for the
original contribution will be effectively lost.
Review Your Estate Plan – A downturn in
investment values actually presents an opportunity from an estate planning perspective. For example, if you intend to pass on an investment portfolio
to your children on death, an estate freeze now can make sense as it will lock-in the tax that will
become payable on your death. Under an estate
freeze, the current value of the portfolio is frozen in
a corporation for your benefit while allowing future
growth to accrue to others, such as your children.
If you completed an estate freeze in the past,
the downturn also represents an opportunity to
enhance that freeze. In particular, if the value of the
corporation has declined since the freeze, it may
be possible to re-freeze your preferred shares at a
lower value, thereby reducing the amount that will
be taxed on your death.
Consider a Share Redemption – Where cash flow
is needed and you have completed an estate freeze
in the past, you may want to consider whether it
makes sense to redeem some of your estate freeze
shares in order to receive cash now. A redemption
of such shares will usually result in a deemed
dividend and will also lower the value of the estate
freeze shares that will eventually be disposed of on
your death.
Seek Tax Advice Before Settling Debts – If
you settle a commercial obligation (basically,
a debt where the interest is deductible for tax
purposes) for less than its face amount, adverse tax
consequences can arise for the debtor. Also, similar
problems can arise where debt is transferred to a
related party. Therefore, you should seek specific
tax advice before a debt is settled or transferred.
Review Your Tax Instalment Obligations – If
your total tax liability, less the portion that was
withheld at source, is greater than $3,000 for both
the current year and either of the two preceding
years, you are required to make instalments for
the current year. In Québec where provincial tax is
collected by the province, the threshold is $1,800
for both federal and Québec tax. However, when
paying instalments, it is possible to base your
2009 income tax instalments on an estimate of
what your final tax obligation will be for 2009.
If the estimate is correct and you pay ¼ of the
estimate on or before the 15th day of March, June,
September and December, no instalment interest
will be charged. It is important to keep in mind
that if you pay less than the instalments that the
Canada Revenue Agency requires and your final tax
obligation is higher than your estimate, instalment
interest and penalties can arise.
File Your Return Electronically if You Expect a
Refund – If you will receive a refund when you file
your 2008 personal tax return, remember to file the
return electronically so that you will receive your
refund faster. Electronically filed returns are usually
assessed in less than 2 weeks (compared to 6-8 weeks
or more for paper returns).
Tax Planning Ideas for Corporations
There are a number of ways to reduce or defer tax if you have a corporation.
Capital Loss Planning – As was the case for individuals, corporations can trigger capital losses and where these losses exceed current year gains,
the resulting net capital loss can be carried back
to the previous 3 taxation years (see the earlier
discussion on the rules for individuals). In the case
of a corporation, prior year taxable capital gains
were subject to refundable tax. So, if a dividend
was paid by your corporation in the prior 3 years,
the refundable tax associated with these gains may
have already been refunded to your corporation.
Where this is the case, it may make sense to carry
capital losses forward to apply against future gains.
Corporate Group Loss Utilization – Where you
have more than one corporation, you may find that
you have income in one corporation and losses in
another (or property with an accrued gain in one
corporation and property with an accrued loss in
another). If this is the case, there are a number of
strategies to consider, including:
- Merge the corporations – It may be possible
to merge one or more corporations together so
that income and losses (or capital gains and
capital losses) are offset directly.
- Review intercorporate interest and expense
charges – Subject to reasonability, it may be
possible to adjust intercorporate charges so
that income is increased for corporations with
unapplied losses.
- Transfer a gain property to a loss
corporation before a sale – Depending on the
circumstances, it may be possible to transfer a
property with an accrued gain to a corporation
with unapplied losses prior to a sale. This
could allow the loss corporation to use its
losses to offset the gain.
- Loan funds to loss corporations without interest – Where a corporation has losses,
an interest-free loan to that corporation will
enhance its ability to generate income.
Consider a Holding Company – A holding company
can provide a number of benefits, including:
- Pay out corporate earnings of a subsidiary
corporation as a tax-free intercorporate
dividend – Where dividends are paid by a
subsidiary to a holding company, this may
provide asset protection for the amount paid,
and may help ensure that the shares of the
corporation remain eligible for the capital
gains exemption.
- Cash in the tax cost of shares that you
have acquired – If you bought shares of a
corporation, and your tax cost is higher than
the paid-up capital of the shares, you may
be able to transfer your shares to a holding
company in return for debt or paid-up capital,
which can be repaid tax-free. This planning
may not be possible if you acquired shares
from a relative.
- Protect tangible assets such as land and
buildings from business risk – A holding
company can also provide protection
for tangible property such as land or
buildings. This property can be held in a
holding company even if it is being used
by a subsidiary in its business. The holding
company shares can still be eligible for the
capital gains exemption if certain conditions
are met.
- Protect “GRIP” from future losses – Under the dividend taxation rules, a private
company can pay eligible dividends (which
are taxed at a lower rate) to the extent that
the corporation has a positive balance in its
general rate income pool (GRIP) at year-end.
If a corporation has losses in the future, this
GRIP balance could be eroded. Paying the
GRIP balance to a parent company as an
eligible dividend can protect that balance from
future losses. Your BDO advisor can help you
determine whether your corporation has a
GRIP balance.
Consider Paying Dividends from Your
Corporation – If your corporation has had capital
gains in the past or received life insurance
proceeds, consideration should be given to paying a tax-free capital dividend now. Depending on the
circumstances, future capital losses can reduce
the amount that can be paid as a capital dividend. Therefore, consider paying any capital dividends
before triggering any capital losses. Also, if your
corporation has refundable dividend tax on hand,
paying a dividend to trigger a refund of this tax in
your corporation may make sense (especially if
your corporation can pay an eligible dividend).
Review Your Corporation’s Instalment
Obligations – A corporation can pay instalments
based on an estimate if you believe that its
corporate income tax for the current year will be
lower (interest and penalties will arise if tax is
underestimated).
Review Your Remuneration Strategies – If
corporate income falls, you should review your
owner-manager remuneration planning to
determine whether dividends or salary should be
paid. Also, when cash is tight, this would be a good
time to revisit income splitting strategies to ensure
you pay as little tax as possible on distributions
from your corporation. For example, it may be
possible to pay dividends to adult family members
with little or no tax.
Have Your GST and PST Status Reviewed – When cash is tight, it will be more important than
ever to ensure that you are not overpaying GST
and PST. In addition, you may be charging tax in
situations where it is not required, and addressing
this will be beneficial if it means your customers
will have more money to spend on your products
or services.
Ensure Research and Development (R&D) Costs
are Identified and Claimed – Many Canadian
corporations are engaged in R&D and they don’t
know it. Most people associate R&D with work
done in a laboratory by skilled scientists. However,
R&D activities for small and mid-sized businesses
are often integrated with daily business activities. Your BDO advisor can help you ensure that all R&D
activities are identified and investment tax credit
claims are maximized.
Contact your BDO advisor to discuss which planning
ideas will be beneficial for you. Keep in mind that the ideas
discussed are not exhaustive. Your BDO advisor can review
your situation to help identify any additional tax planning
ideas that can help you through the difficult economic times
we are now facing.
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