Canada, tax, TaxBreaks, reduce taxes, October 2005 newsletter, Deloitte, Canada

TaxBreaks, October 2005

Contribute to your RRSP
Claim the $500,000 capital gains deduction
Stagger taxes on certain capital gains
Defer the tax on certain stock option benefits
Use your capital losses
Offset taxable income with an allowable business investment loss
Donate
Repay shareholder loans
Declare a bonus
Check whether interest on your loans is deductible
Plan to receive certain income or disburse certain expenses
Make certain disbursements before the end of the year
Make your December instalment
Plan how to cash your retirement allowance

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In 2005, the Canadian economic and political landscape did not compel the federal, provincial, or territorial governments to propose extensive income tax changes for individuals. There is every reason to believe that the same will hold true in 2006. This does not mean that tax planning does not apply to your current situation, as you should always strive to minimize your tax burden, whether you work, are retired, operate a business directly, or operate a business through a corporation. Fall is always a good time to take stock of one’s tax status. As several weeks remain before the end of the year, now is the time to review your 2005 transactions and make the necessary adjustments. Here are fourteen ways, among others, to save on taxes for 2005.

1. Contribute to your RRSP
If you haven’t yet contributed to your RRSP for 2005, don’t wait until the end of February 2006, contribute now. The earlier you contribute to your RRSP, within the allowable limits, the more quickly the capital to finance your retirement will grow sheltered from tax.

2005 contribution. Your maximum contribution for 2005 is 18% of income earned in 2004, principally from employment or a business, up to a maximum of $16,500 (compared to $15,500 in 2004). The maximum RRSP contribution for 2005 applies to earned income of $91,667 in 2004. If you participate in a pension plan, you should keep the pension adjustment in mind — and the pension adjustment reversal, if applicable. To find out the exact amount that you can contribute, look at the “RRSP Deduction Limit Statement for 2005” section of your federal assessment notice for 2004, or access your personal file on the Canada Revenue Agency web site.

Think ahead to 2006. The RRSP limit will increase again in 2006, when it will reach $18,000. If you have your own corporation, have no other source of earned income, and are able to do so, pay yourself a salary of at least $100,000 this year if you wish to ensure that you can contribute the maximum amount to your RRSP in 2006.

Unused RRSP contribution room. If you contributed less than the maximum allowable amount to your RRSP in a previous year, and if you can afford it, use the unused RRSP contribution room for 2005 by contributing an additional amount equal to the unused room. Don’t wait too long to use up unused room, as doing so will give you less time to reap the benefits of compound interest, and you will consequently have less capital in your RRSP when you retire. Remember that your investment horizon may be for 10, 20, or even 40 years, depending on how old you are now and at what age you think you will need funds from your RRSP.

Be careful of overcontributions. The law allows you to contribute up to $2,000 over the authorized maximum. Do not exceed this limit, because the penalty of 1% per month on overcontributions can add up fast, and the administrative formalities to recover excess contributions are relatively complex.

If you turn(ed) 69 in 2005. If you turn(ed) 69 in 2005, you must terminate your RRSP no later than December 31. It is extremely important not to wait until the last minute to plan the maturity date of your RRSP. If you fail to decide how you wish to receive your retirement income before December 31, the full market value of your RRSP will be added to your taxable income in 2005. There are many options available: transferring your RRSP to a Registered Retirement Income Fund (RRIF), receiving an annuity, receiving a lump sum, or choosing a combination of these options. Discuss them with your tax advisor.

Is your spouse younger than you? If your spouse is younger than you and you anticipate that his or her retirement income will be less than yours, consider creating a spousal RRSP. You can then continue contributing to the spousal plan until your spouse turns 69, provided that you have unused contribution room.

2. Claim the $500,000 capital gains deduction
Small business corporation shares and qualified farm property (including shares of a corporation and partnership interests) still qualify for the lifetime capital gains deduction of $500,000. Claiming this deduction often requires a good dose of planning and help from your tax advisor. If you are thinking about selling the assets that qualify for this deduction before the end of the year, consult your tax advisor as soon as possible.

If you have already claimed the $100,000 personal capital gains deduction (abolished in 1994), you are entitled to a maximum deduction of only $400,000. If you plan to use this deduction in 2005, check with your tax advisor to find out whether you have realized an allowable business investment loss (ABIL) in prior years or have cumulative net investment losses (CNILs) as at December 31, 2005, as these will be taken into account, and it is possible that you will not be able to claim the full deduction.

3. Stagger taxes on certain capital gains
If you dispose of property on which you realize a capital gain, you can stagger the payments on this gain over up to five years if you allow the seller to stagger the payment of the proceeds from the sale over a five-year period as well. The term is increased to 10 years for the transfer of farm property, shares from a family farm corporation, or from a small business corporation when this transfer is carried out in favour of a child, grandchild, or great-grandchild living in Canada.

4. Defer the tax on certain stock option benefits
If you exercised stock options in 2005 on publicly traded shares and expect to keep these shares until at least December 31, 2005, you can defer the benefit related to exercising options worth $100,000, as this amount is based on the fair value of the shares at the time the stock options were granted. To defer the benefit, you have to notify your employer before January 16, 2006, so this information can be included in your T4 (Relevé 1 in Québec) for 2005. Your tax advisor can help you to determine whether the deferral is beneficial and, if so, how to optimize it.

5. Use your capital losses
Under the tax rules governing capital losses, you can use your 2005 capital losses to decrease the current year’s taxes if you have realized at least an equal amount in capital gains. Many taxpayers also sell their investment losses before the end of the year once they have realized significant gains earlier in the year. But be careful! If, within the 30 days prior to or following the sale of an asset that resulted in a capital loss, you purchase an identical asset, the superficial loss rules prevent you from claiming a capital loss on an asset you clearly intended to continue holding. This rule also applies if your spouse or a company under your control purchases the identical asset.

6. Offset taxable income with an allowable business investment loss
Whereas capital losses can be used only to reduce capital gains, an ABIL can be used to reduce your overall income. Therefore, if you are a shareholder or creditor of a financially unstable private corporation, consider selling your shares or debt to an unrelated person before December 31 to realize an ABIL for 2005. Remember, however, that if you have already claimed a capital gains deduction in the past, the amount of the ABIL is reduced by the claimed amount. Furthermore, pay particular attention to the documentation related to this loss, as the tax authorities could require you to produce it during the assessment process.

7. Donate
If you have not already done so, now is an ideal time to reconsider your donation plans for 2005 and benefit from the charitable donations tax credits. The federal credit is equal to 16% of the first $200 of charitable donations paid in the year and 29% for any donation in excess of $200 (13.36% and 24.22%, respectively for Québec residents). For tax purposes of the territories and provinces other than Québec, the credit varies from 4% to 11% for the first $200 and from 11.16% to 18.02% for amounts exceeding $200. For Québec tax purposes, the tax credit is equal to 20% of the first $2,000 and 24% of the excess.

Another interesting tax strategy, for both you and the charity, is to donate publicly traded company shares from your portfolio, especially if these shares include a significant unrealized gain. In this scenario, you will benefit from an easing of the capital gain you realized on the donation, as it will be taxed at 25% rather than 50%, and the charitable organization will receive a larger amount than it would have received if you were to sell the shares and donate the proceeds after paying taxes on the gain.

If you are thinking about making a charitable gift before the end of the year and exercising stock options acquired during the same period, then donating these shares to a charity can also be an effective tax-saving strategy, since you could deduct 75% of the benefit you received, which in the end means that you will only be taxed on 25% of the exercised options. This easing measure only applies in respect of shares acquired that were donated in the year and in the 30 days after the option was exercised. Under such circumstances, it seems preferable to exercise the option and donate the shares rather than to sell them once the options are exercised and donate the proceeds.

8. Repay shareholder loans
If you took a loan from your corporation in 2004, repay it before the end of 2005. If you delay, the full amount of the loan will be added to your income for 2004. An exception is available if the loan was made to an employee-shareholder for purchasing a residence, securities issued by the employer, or a car for work purposes. Other restrictions apply to these types of loans, however.

9. Declare a bonus
The small business tax deduction (SBD) is available to Canadian-controlled private corporations with incomes of less than $300,000 in 2005. This deduction was $250,000 in 2004 and, to date, no change has been announced for 2006. If the company’s fiscal year is not a calendar year, the amounts must be determined on a pro rata basis from the number of days in its fiscal year that are situated in each of the calendar years. If the active business income derived from your company exceeds the $300,000 threshold (or any amount between $250,000 and $300,000, according to the date of its fiscal year-end in 2005), it would be good tax planning for the corporation to pay out a bonus to bring its income below the threshold. Your company will be able to claim the tax deduction as long as the bonus is paid within 180 days of your corporation’s fiscal year-end.

10. Check whether interest on your loans is deductible
To be able to deduct loan interest when computing your income, the loans must have been contracted for the purpose of earning income from a business or property. If you are currently paying interest that is not deductible (for example, on a home mortgage loan, on a loan to contribute to your RRSP, or to acquire an interest in a life insurance policy), ask your tax advisor if you could reorganize your business affairs to make the interest deductible. Recent legal precedents and the administrative positions of the Canada Revenue Agency regarding interest deductibility should prompt taxpayers to at least review their current situation. Consult your tax advisor.

If you are a taxpayer living in Québec, you will also have to consider the rule, introduced in 2004, which limits the deduction of financing costs related to “passive” investments to the amount of investment income generated from these investments. If your 2004 financing costs were limited by the application of this rule and you were unable to carry back the amount exceeding the limit to prior years, check if you could increase your investment income in 2005 to absorb both your financing costs from 2005 and your excess financing costs from 2004. As the capital gains are part of the investment income for purposes of this rule, you could realize additional capital gains for this purpose, if circumstances permit.

11. Plan to receive certain income or disburse certain expenses
Good tax planning often includes, among other measures, being able to determine in what year income will be received or an expenditure will be deducted. This planning is effective in cases of capital gains and losses, since investors can decide when they will dispose of their investments, or in cases of business income, for example, where business owners can decide the year in which they will acquire depreciable assets or make maintenance expenses. Employees have much less latitude in this respect, since their employment income is taxable in the year in which they receive it, and since there are very few tax rules related to the deferral of employment income, for example, those concerning sabbatical years. Since each case is unique and the tax rules are often complex, discuss them with your tax advisor.

12. Make certain disbursements before the end of the year
Some deductions and credits can only be claimed if the amount was disbursed before the end of 2005. This is the case for charitable donations, child support (if deductible), childcare expenses, interest on loans for investment purposes, tuition fees, and union and professional dues.

13. Make your December instalment
If you are required to pay your income taxes in instalments and estimate that your 2005 income will be significantly less than it was in 2004, decrease the amount, if you have not already done so, of your December 15, 2005 instalment. However, be careful when making this estimate: if your actual income in 2005 is higher than expected, you could be required to pay interest that is not tax-deductible.

14. Plan how to cash your retirement allowance
If you retire(d) or lost your job in 2005 and your employer has to pay you a retirement allowance by the end of the year, find out if all or some of the money can be paid directly into your RRSP. In addition, ask your tax advisor and your employer if it would be advisable for you to have the portion of your retirement allowance that is not transferable to your RRSP paid out over more than one taxation year. This would allow you to minimize your taxes if you expect your 2006 income to be significantly lower than in 2005.

Jean-Luc Beauregard, Montréal

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