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It’s that time of year again — when you start receiving information slips and compiling the other documents you need to file your 2006 income tax returns. We would like to draw your attention to certain changes made in 2006, as well as to other noteworthy tax matters.

Filing tax returns
To benefit from the Canada Child Tax Benefit, the Quebec child assistance payment and similar programs offered in most other Canadian provinces, each spouse or common law partner must file an income tax return, even if one receives no income. The same applies for claiming the federal GST/HST tax credit or the Quebec QST tax credit.

If you are a student and want to carry forward tuition fees that you cannot claim in 2006 (because you did not have an income or because your income was not high enough), you should also file a tax return. If you are a Quebec resident, you should file Schedule 11 with your federal return and Schedule M with your Quebec return so that the tax authorities can track these amounts. If you reside in a province other than Quebec, you should attach Schedule 11 of your province of residence to Schedule 11 of the federal return.

Indexation and other changes
The tax brackets and non-refundable income tax credits were indexed by 2.2% at the federal level and 2.03% in Quebec. New Brunswick, Ontario, Saskatchewan, Alberta, British Columbia and the three territories also increased most of their non-refundable income tax credits. Manitoba only increased the basic personal amount but also decreased the income tax rate applicable to taxable income between $30,544 and $65,000 from 14% to 13.5%.

Effective July 1, 2006, Prince Edward Island and Nova Scotia residents who have children under six can claim $100 per child every month as a non-refundable credit. In 2006, Manitoba introduced a non-refundable credit related to adoption fees that can attain $10,000; this credit is similar to the credit introduced by the federal government and several other provinces in 2005.

In 2006, Nova Scotia introduced an amount of $1,000 to its non-refundable credits for students who obtained a post-secondary diploma from an admissible educational institution; the province also raised the sport and recreational expenses that qualify for a non-refundable credit from $150 to $500.

Several other changes were made to federal legislation in 2006. Although most of them do not yet have the force of law, they have already been included in the 2006 income tax returns. Noteworthy changes include the following:

• Universal Child Care Benefit. The $100 per month being paid for each child under the age of six since July 1, 2006, is taxable at both levels of government for the spouse or common law partner with the lower net income. An information slip (RC-62) to this effect will be issued shortly.
• If you are eligible for the education amount, the related scholarships, fellowships and bursaries that you have received over the course of the year are not taxable.
• In addition to the education amount, you can now claim an amount for textbooks. The credit amount is $65 for each month of full-time post-secondary studies and $20 for each month of part-time studies.
• If you were an employee, you are eligible for the Canada Employment credit for an amount up to $250.
• If you received pension income that entitles you to the pension amount, this amount has been increased to $2,000 from $1,000. This increase has not been adopted in Quebec.
• Effective July 1, 2006, you can request a credit for the cost of a monthly or longer-duration public transit pass that allows you to travel by local city bus, tramway, metro, commuter train, commuter bus or local ferryboat.

Eligible dividends
If, in 2006, you held shares in public corporations or other corporations resident in Canada that are not Canadian-controlled private corporations (CCPC), the dividends you received from these corporations should be, as a general rule, eligible dividends. Similarly, if you were a shareholder of a CCPC and, in 2006, had received dividends from this corporation’s income taxed at the general rate, these dividends are most likely eligible dividends. In Quebec, only dividends received from such corporations after March 23, 2006, are considered eligible dividends.

Once they have been included in your federal taxable income, eligible dividends are grossed up by 45% and entitle you to a dividend tax credit of approximately 19% of the grossed-up amount. Dividends that are not eligible dividends are grossed up by 25% and entitle you to a 13.33% credit of the grossed-up dividend. The credit rate for dividends that applies to eligible dividends differs for each province and territory. The table below shows the credit rate, in percentages, for the dividends of provinces and territories depending on whether or not they are eligible dividends. For comparison purposes, we have also included the 2005 dividend tax credit.

¹ The Quebec rate is 10.83% for all dividends paid out from January 1, 2006, to March 23, 2006, inclusively.

How will you know if the dividends you have received are eligible dividends? By law, the corporation paying out the dividend must designate it as an eligible dividend. It is therefore up to the corporation to designate the dividends that are eligible on the information slips that you will receive, whether they are paid directly by that corporation or through your broker. This information can be found on slips T5 (box 25), T4PS (box 25), T3 (box 32) or T5013 (box 51 1). In Quebec, you will find the same information on Relevés 3 (box B), Relevés 25 (box F), Relevés 16 (box I) and Relevés 15 (box 6A).

In order for the actual dividends, the grossed-up dividends, and the dividend tax credits to be properly calculated, it will be very important to correctly enter the dividends depending on their type in Schedule 4 as well as on lines 120 and 180 of the federal return. The same applies for lines 128 and 167 of the Quebec return. Dividend tax credits, for their part, are calculated on line 425 of the federal return, on line 415 of the Quebec return, and on line 6152 of the Tax and Credit schedule of other provinces and territories.

With these changes, the federal alternative minimum tax (AMT) (15.25%) becomes higher than the marginal rate applicable to eligible dividends (14.55%). It is therefore likely that the AMT applies in some cases, for example, if your only source of income in 2006 was eligible dividends that exceeded the AMT application threshold ($40,000). As a result, the total federal and provincial or territorial income tax liability may be slightly higher than the total income tax calculated at the ordinary rates. However, any AMT paid may be recovered during any one of the seven subsequent years to the extent that your ordinary income will be greater than your minimum income tax during those years and up to the maximum of this difference. The minimum tax does not apply in Quebec in this situation, as the Quebec AMT rate (16%) is less than the marginal rate applicable to eligible dividends (17.54%).

Mutual funds and income trusts
If your non-RRSP portfolio contains mutual fund or income trust units, pay particular attention when calculating the cost of these units, i.e., their adjusted cost base (ACB). To avoid double taxation, the ACB of such units must be increased by the amount of periodic income distributed in the form of additional units. Furthermore, the amounts you periodically receive from income trusts often include the payment of a capital sum, which must be deducted from the ACB. By taking these adjustments into account, you can correctly calculate your capital gains or losses when you sell these investments.

Foreign mutual funds and other foreign investments
If you hold investments in foreign mutual funds or interests in other foreign investments you have undoubtedly become acquainted with the proposed rules concerning foreign investment entities (FIEs). The latest update of this federal legislative proposal, tabled in the House of Commons on November 22, 2006, defers to fiscal 2007 as the year the rules will apply (rather than 2003), but does not fundamentally change the previous version that was published July 18, 2005. These rules were created to put an end to the particular benefits enjoyed by Canadians holding foreign mutual funds which were not available to those holding Canadian mutual funds.

If, during 2003, 2004, and 2005, you paid income taxes based on these new rules, even though they were not yet adopted, make sure to modify your tax returns accordingly. We would advise you to consult a tax expert on this matter and to find out whether, effective 2007, your interests in foreign mutual funds or other foreign investments are FIEs and if they are still subject to the new rules and, if the case may be, also to establish the amount to be added to your income.

Net capital losses
First, you need to determine if your total losses upon disposing of investments and other property in 2006 exceed your capital gains. If they do not, you will have realized a lower net capital gain because of such losses, and half the net gain is taxable. If, on the other hand, the total amount of your losses is greater than your gains, the tax laws provide an alternative: you can either use the loss in future periods against future capital gains, or, if you have declared a net capital gain in one of the three previous years (2003, 2004, or 2005), you can carry it back.

Carrying net capital losses from 2006 back to previous years can generally be a good move, because you will immediately recover income tax that you have already paid. Elections to carry back losses must be made using the appropriate forms (T1A for federal tax and TP-1012.A-V for Quebec) and not by filing a modified return. The federal T1A form can be joined to your income tax return or sent under separate cover, but the Quebec TP-1012.A-V form must be sent under separate cover. If your income tax returns are filed electronically, you must send a printed version of this form to the appropriate tax authorities in Quebec.

Amount for persons with disabilities
If you are claiming the disability tax credit for the first time, you must have Form T2201 filled out by a physician or another authorized person and file it with tax authorities. This form must be received and examined by tax authorities before your income tax return is assessed. If you have already filed this form for a previous taxation year, you do not have to file it again. The fact that you receive a disability benefit under the Canada Pension Plan or the Quebec Pension Plan does not necessarily make you eligible to claim the disability tax credit. The equivalent of the disability tax credit in Quebec is the amount for a severe or prolonged mental or physical impairment. The required form is TP-752.0.14-V.

Charitable donations
Before May 2, 2006, the capital gains inclusion rate from donations to a qualified donee of publicly listed securities was 25%. Since May 2, 2006, these gains are no longer taxable. You must nevertheless declare these dispositions for federal tax purposes by filling out form T1170. In Quebec, only donations of publicly listed securities made before May 2, 2006, must be listed on form TP-231. In addition, the amount starting from which the 24% credit is granted in Quebec was lowered from $2,000 to $200; the credit remains fixed at 20% on the first $200 tranche.

Stock options
If, in a previous year, you elected to defer the benefit related to the exercise of stock options and you were still holding these shares as at December 31, 2006, do not forget to fill out and attach form T1212 to your federal income tax return. This form advises the tax authorities that you are still holding these shares and that the measures deferring the tax on this benefit are still in force. This form has no equivalent under Quebec legislation.

Transfer of dividends between spouses
At the federal level, you may choose to add to your income all of the taxable dividends of taxable Canadian corporations that your spouse received, or is deemed to have received, if doing so increases your claim for the spouse or common-law partner amount. You would normally elect this choice if the amount for your spouse or common-law partner would be reduced by the fact that your spouse received dividends but would not be subject to tax. The dividends that you chose to include in your income are excluded from your spouse’s income. Using this option can maximize the tax credit for dividends and the amount for your spouse or common-law partner and thereby reduce the federal taxes payable. In Quebec, because your spouse can transfer to you his or her portion of non-refundable tax credits that did not serve to reduce his or her own taxes, the option of including the dividends received by your spouse in your income is not available.

Adjustment of investment expenses (Quebec)
The deduction for investment expenses you incur to earn investment income cannot exceed the income from these investments. You must complete Schedule N, “Adjustment of Investment Expenses” if, in 2006, you incurred investment expenses such as a loss by a partnership in which you were a specified member, the expenses incurred to earn investment income, or a resource deduction. If your investment expenses exceed your investment income, you must record the calculated adjustment amount on line 260 of your income tax return. Losses incurred from the rental of property are not considered investment expenses as defined by this measure. Another adjustment must be performed, on line 276 of your return, if you claimed a net capital loss from other years or a loss related to a partnership in which you were a limited partner. This measure applies to all taxpayers who file tax returns in Quebec. Furthermore, the amounts recorded on lines 260 or 276, depending on the circumstance, could be used to reduce your investment income of the previous three years, or of subsequent years. To reduce your net investment income of previous years, complete form TP-1012.B-V and file it separately from your return.

Contribution to the Quebec Parental Insurance Plan (Quebec)
The Quebec Parental Insurance Plan (QPIP) stipulates that benefits be paid to all eligible workers — salaried or self-employed — who take maternity leave, paternity leave, parental leave, or adoption leave. This plan replaces the maternity benefits, parental benefits, and adoption benefits previously available to new Quebec parents under the federal employment insurance plan. Although your QPIP contributions were deducted at source if you were a Quebec taxpayer with employment income in 2006, you must contribute to the QPIP and fill out new Schedule R if you are declaring business income, if you have worked in Canada but outside Quebec, or if you have worked outside of Canada. The maximum QPIP contribution is $420.09 if you are self-employed and is treated like a QPP contribution: a portion of the amount paid qualifies for a non-refundable tax credit whereas the other portion is deductible from your income calculation. The contribution amount, however, is $237.12 if you were a Quebec resident who worked outside of Quebec, and it qualifies for a non-refundable tax credit. Because the deduction or credit is also admissible for federal income tax purposes, you must also fill out the new Schedule 10 of the federal return.

Jean-Luc Beauregard, Montreal
Marina Panourgias, Toronto

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