TaxBreaks, February 2005
What’s new in your 2004 tax returns?
Contribute to your RRSP for 2004
How to Reduce the Tax You Pay - New Edition
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What’s new in your 2004 tax returns?
As information slips and other documents required for your 2004 tax returns start to trickle in, we would like to draw your attention to certain changes made in 2004, as well as to other noteworthy tax matters.
Filing tax returns
To benefit from the federal government’s Canada Child Tax Benefit, the Québec child assistance payment and similar programs offered in most other Canadian provinces, both spouses of a household must file income tax returns, even if one spouse does not have income. The same goes for taxpayers wishing to claim the federal GST/HST tax credit or the Québec QST tax credit. If you are a student and want to carry forward tuition fees that you were not able to claim in 2004, you should file Schedule 11 with your federal return and Schedule M with your Québec return so that the tax authorities can track these amounts.
Indexation and other changes
You will notice a slight increase in tax brackets and personal credits in 2004 at the federal level and in Québec, following their indexation. The same goes for Ontario, Saskatchewan, British Columbia and the three territories. In Nova Scotia, the rate used to calculate provincial taxes was lowered from 9.77% to 8.79% for taxable income of $29,590 or less, and a new bracket of taxable income of 17.5% was added for individuals who have a taxable income of over $93,000. In Manitoba, the rate used to calculate taxes on taxable income between $30,544 and $65,000 was lowered from 14.9% to 14%. The tax rates applicable to all other provincial taxable income brackets remain unchanged.
Ontario taxpayers must pay the new health premium created by the Minister of Finance in his May 18, 2004 budget speech. This premium is calculated according to taxable income, and the $900 annual maximum is reached when taxable income exceeds $200,600. However, as this premium took effect on July 1, 2004, taxpayers have to pay only 50% of it in 2004, for a maximum contribution of $450. Self-employed workers in Ontario who hire apprentices in qualifying skilled trades have been entitled, since May 19, 2004, to an apprenticeship training tax credit whose maximum is $15,000 ($5,000 per year) per apprentice in his or her first 36 months of an eligible program.
The maximum credit for political contributions at the federal level and in Saskatchewan rose from $500 to $650, and the equivalent credit in Alberta increased from $750 to $1,000.
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 the mutual fund units or income trust 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 must determine if the new rules concerning foreign investment entities (FIEs) apply. These rules have been applicable since 2003, even though their final version, published on October 30, 2003, has not yet been adopted. The 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.
FIE rules are complex and cannot be summarized in a few sentences. For more information, please refer to the Winter 2004 issue (04-1) of our Executive TaxBreaks newsletter. We would advise you to consult a tax expert to find out whether your interests in foreign mutual funds or other foreign investments are FIEs and if they are subject to the new rules, and also to establish the amount to be added to your income.
Do you have net capital losses?
First, you need to determine if your total losses upon disposing of investments and other property in 2004 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 declared a net capital gain in 2001, 2002 or 2003, you can carry it back.
Carrying net capital losses from 2004 back to previous years can 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 for Québec) 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 Québec TP-1012.A form must be sent under separate cover. If your income tax returns are filed electronically, you must send a printed version of these forms to the appropriate tax authorities.
Measures affecting retirement savings
The ceiling for contributions to retirement savings plans has been increased: it rose from $14,500 in 2003 to $15,500 in 2004. For 2004, the maximum annual contribution to an RRSP is 18% of earned income in 2003 up to a limit of $15,500. In other words, in order to contribute the maximum amount to your RRSP in 2004, you must have had at least $86,111 in earned income in 2003. If, however, you participate in a registered pension plan or a deferred profit sharing plan, you must take your 2003 pension adjustment into account when determining the allowable contribution to your RRSP in 2004. Generally, the pension adjustment will reduce the amount you can contribute to your RRSP.
Amount for persons with disabilities
If you are claiming the disability tax credit for the first time, don’t forget to 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 Québec Pension Plan does not necessarily make you eligible to claim the disability tax credit. The equivalent of the disability tax credit in Québec is the “amount respecting a severe or prolonged mental or physical impairment.” The required form is TP-752.0.14.
Before 2004, a disabled person could claim the following as an expense: the personal care given by a caretaker that would allow the disabled person to attend an educational institution or to earn employment income, self-employed income, or a grant. In 2004, the scope of this deduction was expanded and now includes attendant care expenses as well as other expenses that a disabled person incurs for products and services that help him or her to earn income despite the handicap. At the federal level, form T929 must be used to claim the deduction. In Québec, the form is TP-358.0.1.
Stock options
If, in a previous year, you elected to defer a benefit related to the exercise of stock options, and you still held these shares on December 31, 2004, do not forget to fill out and attach form T1212 to your federal income tax return. This form indicates to 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 Québec legislation.
The deduction for stock options at the federal level is still 50% of the benefit. In Québec, however, the similar deduction that you may claim on line 297 (Miscellaneous deductions) of your income tax return is equal to 25% of the taxable benefit related to the shares if the deduction is due to a sale that took place after March 30, 2004. For sales that occurred before March 31, 2004, the deduction is 37.5%.
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 your amount for your spouse or common-law partner was reduced by the fact that your spouse received dividends but is not 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 Québec, since 2003, 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 into your income is not available.
Final year in which to use the exempt capital gains balance
The federal budget of February 22, 1994 abolished the $100,000 exemption that could, until that time, apply to the capital gains that a taxpayer could realize upon the disposal of most of their assets. If, for the 1994 tax year, you made an election (federal form T664) concerning a “flow-through entity” (e.g., a mutual fund trust or a partnership), these assets were presumed to have been disposed of at their fair market value, and the realized gain was recorded in an account named “exempt capital gains balance.” Since either you realized capital gains on such properties after 1994, or such entities awarded you capital gains or business income arising from the disposition of eligible capital property, those gains could have been made exempt up to the amount recorded in this account. If, as at December 31, 2004, your exempt capital gains balance was not reduced to nil, the amount of the balance will be added to the cost bases that you still hold in the entity. Similar rules also exist with respect to eligible capital property (e.g., goodwill) with the “exempt gains balance.”
Including the balance of the income as at December 31, 1995
The tax rules concerning the definition of the term “fiscal period” were amended in 1995. For example, if you were a member of a partnership in 1995, you may have had to record income related to a period of more than 12 months in your income tax return. To lower the tax consequences of this amendment, a mechanism called “income as at December 31, 1995” was implemented. This mechanism allows you to distribute the excess income over the 10 following years. Year 2004 was the final year in which these rules applied. If, from 1995 to 2003, you included the minimum amount required by law in your annual income, you must include, in 2004, 15% of the “income as at December 31, 1995.” This inclusion could have an influence on the calculation of your 2005 tax instalments. Discuss this matter with your tax advisor.
Adjustment of investment expenses (Québec)
Since March 31, 2004, the deduction of investment expenses you incurred to earn investment income cannot exceed the income derived from these investments. If, in 2004, you incurred investment expenses such as a loss from a partnership in which you were a specified member, expenses incurred to earn investment income, or a resource deduction, you must complete the new Schedule N. 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 for the application of this measure. Another adjustment must be performed, on line 276 of your income tax return, if you have claimed a loss related to a partnership in which you were a limited partner, or if you claimed a net capital loss from other years. A pro rata calculation is performed in both instances to take into account that the measure applies only since March 31, 2004. All taxpayers who file returns in Québec must consider whether this new measure applies to them. 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 subsequent years. To reduce your net investment income of previous years, complete form TP-1012.B and file it separately from your return.
Québec designated trust
If you resided in Québec on December 31, 2004, and were a beneficiary of a designated trust, you must complete form TP-663, Information Return To Be Completed by the Beneficiary of a Designated Trust, and check Box 22 of your Québec income tax return. The expression “designated trust” means any trust resident in Canada but outside Québec. As a general rule, the residence of a trust is the residence of the trustee.
Under federal legislation, if in 2004 the trustee elected to have the income and taxable capital gains taxed in the hands of the trust, and you are the “designated beneficiary,” then in addition to completing form TP-663, you must include your share of this income when calculating your income for Québec tax purposes. You may be eligible for a tax credit for a beneficiary of a designated trust (line 411 of Schedule E).
A “designated beneficiary” of a trust means a beneficiary who has a share of $5,000 or more of the income interests or 10% or more of the capital interests (or of the income interests) of a designated trust.
The purpose of this measure is to counter certain tax planning measures implemented in the past few years by Québec taxpayers wanting to benefit from more advantageous tax rates offered in other Canadian provinces, namely in Alberta. By requiring designated beneficiaries to include their share of the trust income in their 2004 income tax returns and granting them a non-refundable income tax credit, the Québec government forces these taxpayers to pay the difference between the Québec taxation rate and that of the other province on the income elected by the trustee.
Taxpayers who fail to include this information in the forms, or the amounts in their income tax returns, face severe penalties. You should consult your tax advisor if you are affected by this measure.
Jean-Luc Beauregard, Montréal
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Contribute to your RRSP for 2004
Don’t forget that you have until March 1, 2005 to contribute to your RRSP for the year 2004.
How to Reduce the Tax You Pay - New Edition
Our book How to Reduce the Tax You Pay can provide you with valuable information regarding your 2004 tax returns and your 2005 tax planning. You can obtain a copy of the 17th edition, published by Key Porter Books Limited, in bookstores for only $19.95.
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