if you follow my blog, you know that I enjoy reading Tim Cesnick's article published in the Globe & Mail. Once again, Tim's article is a MUST read for all of you. As usual, please do not hesitate to contact me should you wish to discuss some personal tax strategies.
&&&&&&&
The Concept
Income splitting is one of the pillars of tax planning. It involves moving income from the hands of one family member who will pay tax at a higher rate to the hands of someone else in the family who will pay tax at a lower rate. By taking advantage of the lower tax brackets of family members, the overall tax burden for the family can be reduced.
How much tax can be saved? It varies by province, but the average across Canada is $17,000 in potential tax savings annually per family member. Your actual savings will depend on your level of income, your family member’s level of income, and your province of residence. The provinces where the greatest annual tax savings are possible are Nova Scotia ($21,000), Ontario ($19,565) and B.C. ($18,908). Alberta offers the smallest opportunity for annual savings at $13,196.
The Challenge
Here’s the problem: The attribution rules in our tax law are designed to prevent you from simply moving income to someone else’s hands. If you’re caught under these rules, the income earned by your family member will be attributed back to you to be taxed in your hands. The most common situations where these nasty rules will apply are where you give or lend money (at no or low interest) to your spouse or minor children.
The good news? There are quite a few strategies that can be implemented to split income that will sidestep the attribution rules.
The Strategies
Set yourself up for tax savings next year with one of these ideas:
1. Lend money to your spouse or child. You can simply lend money to your spouse or a child for them to invest. In the case of your spouse, all income and capital gains will be attributed back to you, and in the case of minor children, all income (but not capital gains) will face tax in your hands. But second generation income (that is, income on the income) will not be attributed back to you. It makes sense to move the income annually into a separate account so that its growth can be tracked separately from the original loan amount.
2. Lend money to family at interest. This idea is much the same as the one above, except that you can charge interest on the loan to avoid the attribution rules. By charging the prescribed rate of interest (currently just 1 per cent) your family member, not you, will face tax on any income earned. Your family member will have to pay you the interest every year by Jan. 30 for the prior year’s interest charge (if this is overlooked even once, the attribution rules will apply every year going forward). And get this: The current prescribed rate can be locked in indefinitely. So, if you set this loan up before Dec. 31 of this year, the 1-per-cent rate can apply forever. To the extent your family member earns more than 1 per cent on the funds, you’ll effectively split income.
3. Lend or give money to acquire a principal residence. If you help a family member to purchase a home, this will free up the income of that family member for other purposes – such as investing – effectively moving investable assets from your hands to theirs. In addition, if the property appreciates in value, the capital gain could be sheltered using the principal residence exemption of your family member if they are older than 18 or married.
&&&&&&&&&&
Showing posts with label income splitting. Show all posts
Showing posts with label income splitting. Show all posts
Monday, August 29, 2011
Sunday, December 19, 2010
Business owners: 5 resolutions for the New Year!
You are a successful business owner...but are you satisfied with your results?
I didn’t think so. Let me help you make your business even more successful in 2011. Here is how I can help:
1. Setting up a proper share structure
Save on taxes! I’ll say it again, save taxes! Having the right structure allows flexibility in terms of tax planning. While you are only required, in law, to have one class of shares (common), it is always best to provide additional classes of shares so that you will have the needed flexibility. You might want an opportunity to income split between family members and save substantial taxes; to attract new investors and possibly to make use of a family trust. The right share structure will help you save on your tax bill in 2011.
2. Enter a shareholders’ agreement
Because happy endings only happen in Hollywood! Every entrepreneur should understand the importance of a written contract to resolve conflicts. A shareholders’ agreement defines the way in which the company should be governed and managed so as to avoid messy and expensive disputes in the future.
3. Set up a holding company
To protect the assets you need to operate your business. You need operating cash flow, a place of business and equipment to make a profit right? So why would you subject them to attacks from creditors? The best way to protect the assets of an incorporated business is through the use of a holding company (Holdco). And you can also save on taxes because when the operating company has excess cash in the operating company each year, it can pay the excess capital to the Holdco as a tax-free dividend.
4. Use discretionary family trusts to maximize income-splitting
Save taxes (again) thanks to your spouse and children. If you have children and/or are married, you should consider owning their shares through a discretionary Family trust because you can further reduce your income tax bill. The benefits of a family trust include: (a) Income splitting: A well-structured family trust allows for the splitting of income earned by the trust among the various beneficiaries (b) Funding of children’s education at a potential and very low tax rate of 16% instead (c) Multiply the allowable tax free gains (capital gains exemption) should you sell your company: Hence, the $750,000 capital gains exemption may be multiplied by the number of family members who are beneficiaries of the trust, without direct share ownership.
5. Prepare primary and secondary wills
Did you know that you’ll be taxed even when you pass on? Yes, thanks to probate fees! You can save significant probate fees if you have a secondary will? Probate fees are the fees charged by provincial governments to probate your Will when settling your estate. As a result, Ontario’s probate fees for a modest estate of $500,000 now amount to $7,000. In order to avoid probate fees on their corporate holdings (i.e. shares in private companies) and by using the “double will” technique, every shareholder should have a primary and secondary will drafted and executed.
I didn’t think so. Let me help you make your business even more successful in 2011. Here is how I can help:
1. Setting up a proper share structure
Save on taxes! I’ll say it again, save taxes! Having the right structure allows flexibility in terms of tax planning. While you are only required, in law, to have one class of shares (common), it is always best to provide additional classes of shares so that you will have the needed flexibility. You might want an opportunity to income split between family members and save substantial taxes; to attract new investors and possibly to make use of a family trust. The right share structure will help you save on your tax bill in 2011.
2. Enter a shareholders’ agreement
Because happy endings only happen in Hollywood! Every entrepreneur should understand the importance of a written contract to resolve conflicts. A shareholders’ agreement defines the way in which the company should be governed and managed so as to avoid messy and expensive disputes in the future.
3. Set up a holding company
To protect the assets you need to operate your business. You need operating cash flow, a place of business and equipment to make a profit right? So why would you subject them to attacks from creditors? The best way to protect the assets of an incorporated business is through the use of a holding company (Holdco). And you can also save on taxes because when the operating company has excess cash in the operating company each year, it can pay the excess capital to the Holdco as a tax-free dividend.
4. Use discretionary family trusts to maximize income-splitting
Save taxes (again) thanks to your spouse and children. If you have children and/or are married, you should consider owning their shares through a discretionary Family trust because you can further reduce your income tax bill. The benefits of a family trust include: (a) Income splitting: A well-structured family trust allows for the splitting of income earned by the trust among the various beneficiaries (b) Funding of children’s education at a potential and very low tax rate of 16% instead (c) Multiply the allowable tax free gains (capital gains exemption) should you sell your company: Hence, the $750,000 capital gains exemption may be multiplied by the number of family members who are beneficiaries of the trust, without direct share ownership.
5. Prepare primary and secondary wills
Did you know that you’ll be taxed even when you pass on? Yes, thanks to probate fees! You can save significant probate fees if you have a secondary will? Probate fees are the fees charged by provincial governments to probate your Will when settling your estate. As a result, Ontario’s probate fees for a modest estate of $500,000 now amount to $7,000. In order to avoid probate fees on their corporate holdings (i.e. shares in private companies) and by using the “double will” technique, every shareholder should have a primary and secondary will drafted and executed.
Thursday, November 11, 2010
Business Owners: Income Splitting 101 & How can you reduce your tax burden with some Income Splitting" strategies?
if you follow my blog, you know that I enjoy reading Tim Cesnick's article published in the Globe & Mail. Once again, Tim's article is a MUST read for all of you. As usual, please do not hesitate to contact me should you wish to discuss some personal tax strategies.
&&&&&&&
The Concept
Income splitting is one of the pillars of tax planning. It involves moving income from the hands of one family member who will pay tax at a higher rate to the hands of someone else in the family who will pay tax at a lower rate. By taking advantage of the lower tax brackets of family members, the overall tax burden for the family can be reduced.
How much tax can be saved? It varies by province, but the average across Canada is $17,000 in potential tax savings annually per family member. Your actual savings will depend on your level of income, your family member’s level of income, and your province of residence. The provinces where the greatest annual tax savings are possible are Nova Scotia ($21,000), Ontario ($19,565) and B.C. ($18,908). Alberta offers the smallest opportunity for annual savings at $13,196.
The Challenge
Here’s the problem: The attribution rules in our tax law are designed to prevent you from simply moving income to someone else’s hands. If you’re caught under these rules, the income earned by your family member will be attributed back to you to be taxed in your hands. The most common situations where these nasty rules will apply are where you give or lend money (at no or low interest) to your spouse or minor children.
The good news? There are quite a few strategies that can be implemented to split income that will sidestep the attribution rules.
The Strategies
Set yourself up for tax savings next year with one of these ideas:
1. Lend money to your spouse or child. You can simply lend money to your spouse or a child for them to invest. In the case of your spouse, all income and capital gains will be attributed back to you, and in the case of minor children, all income (but not capital gains) will face tax in your hands. But second generation income (that is, income on the income) will not be attributed back to you. It makes sense to move the income annually into a separate account so that its growth can be tracked separately from the original loan amount.
2. Lend money to family at interest. This idea is much the same as the one above, except that you can charge interest on the loan to avoid the attribution rules. By charging the prescribed rate of interest (currently just 1 per cent) your family member, not you, will face tax on any income earned. Your family member will have to pay you the interest every year by Jan. 30 for the prior year’s interest charge (if this is overlooked even once, the attribution rules will apply every year going forward). And get this: The current prescribed rate can be locked in indefinitely. So, if you set this loan up before Dec. 31 of this year, the 1-per-cent rate can apply forever. To the extent your family member earns more than 1 per cent on the funds, you’ll effectively split income.
3. Lend or give money to acquire a principal residence. If you help a family member to purchase a home, this will free up the income of that family member for other purposes – such as investing – effectively moving investable assets from your hands to theirs. In addition, if the property appreciates in value, the capital gain could be sheltered using the principal residence exemption of your family member if they are older than 18 or married.
&&&&&&&&&&
&&&&&&&
The Concept
Income splitting is one of the pillars of tax planning. It involves moving income from the hands of one family member who will pay tax at a higher rate to the hands of someone else in the family who will pay tax at a lower rate. By taking advantage of the lower tax brackets of family members, the overall tax burden for the family can be reduced.
How much tax can be saved? It varies by province, but the average across Canada is $17,000 in potential tax savings annually per family member. Your actual savings will depend on your level of income, your family member’s level of income, and your province of residence. The provinces where the greatest annual tax savings are possible are Nova Scotia ($21,000), Ontario ($19,565) and B.C. ($18,908). Alberta offers the smallest opportunity for annual savings at $13,196.
The Challenge
Here’s the problem: The attribution rules in our tax law are designed to prevent you from simply moving income to someone else’s hands. If you’re caught under these rules, the income earned by your family member will be attributed back to you to be taxed in your hands. The most common situations where these nasty rules will apply are where you give or lend money (at no or low interest) to your spouse or minor children.
The good news? There are quite a few strategies that can be implemented to split income that will sidestep the attribution rules.
The Strategies
Set yourself up for tax savings next year with one of these ideas:
1. Lend money to your spouse or child. You can simply lend money to your spouse or a child for them to invest. In the case of your spouse, all income and capital gains will be attributed back to you, and in the case of minor children, all income (but not capital gains) will face tax in your hands. But second generation income (that is, income on the income) will not be attributed back to you. It makes sense to move the income annually into a separate account so that its growth can be tracked separately from the original loan amount.
2. Lend money to family at interest. This idea is much the same as the one above, except that you can charge interest on the loan to avoid the attribution rules. By charging the prescribed rate of interest (currently just 1 per cent) your family member, not you, will face tax on any income earned. Your family member will have to pay you the interest every year by Jan. 30 for the prior year’s interest charge (if this is overlooked even once, the attribution rules will apply every year going forward). And get this: The current prescribed rate can be locked in indefinitely. So, if you set this loan up before Dec. 31 of this year, the 1-per-cent rate can apply forever. To the extent your family member earns more than 1 per cent on the funds, you’ll effectively split income.
3. Lend or give money to acquire a principal residence. If you help a family member to purchase a home, this will free up the income of that family member for other purposes – such as investing – effectively moving investable assets from your hands to theirs. In addition, if the property appreciates in value, the capital gain could be sheltered using the principal residence exemption of your family member if they are older than 18 or married.
&&&&&&&&&&
Monday, October 11, 2010
A New Chapter in Taxation of Trusts: The Residency of a Trust
Below is an excellent article published by Collins Barrow, Chartered Accountants.
A New Chapter in Taxation of Trusts
The recent decision of the Tax Court of Canada in Garron Family Trust v. R (2009 DTC 1568) has cast doubt on some common international and inter-provincial tax planning structures that involve the use of trusts. Generally, these trust structures reallocated income to jurisdictions that had either lower tax or no tax at all on certain types of income. This was accomplished by implementing a tax strategy that involved a trust and relying on the residency of that trust to determine the jurisdiction in which the trust's income would be taxed.
For over thirty years, tax professionals have relied on the principles set out in the well-known Thibodeau Family Trust case (78 DTC 6376) to determine the residency of a trust. Now, as a result of the decision in the Garron Family Trust case, we appear to have a new set of rules for determining the residency of a trust. These new rules can have a serious impact on any trust tax planning strategy that relies on the old residency rules of the trust to minimize or eliminate taxation.
Pursuant to the Thibodeau case, the residency of a trust was based on the residency of the managing trustees. The Thibodeau trust had three trustees, one resident in Canada and two in Bermuda. The trust was administered in Bermuda and the books and records of the trust were in Bermuda. The Court concluded that the trust resided in Bermuda because the trust document required that a majority of trustees agree on all matters of trustee discretion, and the majority of trustees resided in Bermuda. The Court rejected the notion that the residence of a trust should be similar to that of a corporation, and therefore disregarded the "management and control" test used for corporations. The Court then concluded that the residence of a trust should be determined based on residency of the trustees.
Just over thirty years later, we now have a different opinion from the Tax Court regarding this issue. With the Garron Family Trust decision, the Court has now embraced the notion that the residence of a trust should be similar to that of a corporation. The Court will look to the management and control of the trust to determine residency of the trust. The Court concluded that adopting a similar test of residence for trusts and corporations promotes the important principles of consistency, predictability and fairness in the application of tax law.
With an update in the jurisprudence related to the residency of trusts, the Canada Revenue Agency (CRA) is now aggressively reviewing tax planning structures involving trusts to reduce tax avoidance through international and inter-provincial tax planning.
The CRA recently hired additional auditors to review the residency of Alberta trusts. During the past several years, it has been attractive and popular for individuals located in provinces other than Alberta to set up an Alberta resident trust to access Alberta's low provincial tax rates. With this review of Alberta Trusts, the CRA is seeking to determine the "management and control" over the trust assets. As a result, it has distributed questionnaires to Alberta trustees, requesting the following information:
•a list of the duties and responsibilities as the trustee;
•the signing and/or contracting authority of the trustees; and
•the responsibility of the trustees for the management of any business or property owned by the trust, the banking and financing arrangements for the trust, and the preparation of the trust's accounts and reporting to the beneficiaries.
If the CRA determines that the management and control over the trust assets rests with any person(s) other than the Alberta trustees, it may determine the residence of the trust to be other than Alberta and reassess the provincial taxes accordingly.
Based on the 2010 Federal Budget, and the Department of Finance's desire to close various loopholes in the Income Tax Act, and to try to find ways to generate revenue to assist in reducing the deficit, we can anticipate the CRA will also apply the same aggressive nature toward international tax planning strategies involving trusts.
This may be a new chapter in the taxation of trusts, but the story is not over yet. The Garron Family Trust has requested leave to appeal to the Federal Court of Appeal. We will have to wait for the outcome of that appeal to see whether a new chapter is written once again, or if the book is closed for the foreseeable future.
A New Chapter in Taxation of Trusts
The recent decision of the Tax Court of Canada in Garron Family Trust v. R (2009 DTC 1568) has cast doubt on some common international and inter-provincial tax planning structures that involve the use of trusts. Generally, these trust structures reallocated income to jurisdictions that had either lower tax or no tax at all on certain types of income. This was accomplished by implementing a tax strategy that involved a trust and relying on the residency of that trust to determine the jurisdiction in which the trust's income would be taxed.
For over thirty years, tax professionals have relied on the principles set out in the well-known Thibodeau Family Trust case (78 DTC 6376) to determine the residency of a trust. Now, as a result of the decision in the Garron Family Trust case, we appear to have a new set of rules for determining the residency of a trust. These new rules can have a serious impact on any trust tax planning strategy that relies on the old residency rules of the trust to minimize or eliminate taxation.
Pursuant to the Thibodeau case, the residency of a trust was based on the residency of the managing trustees. The Thibodeau trust had three trustees, one resident in Canada and two in Bermuda. The trust was administered in Bermuda and the books and records of the trust were in Bermuda. The Court concluded that the trust resided in Bermuda because the trust document required that a majority of trustees agree on all matters of trustee discretion, and the majority of trustees resided in Bermuda. The Court rejected the notion that the residence of a trust should be similar to that of a corporation, and therefore disregarded the "management and control" test used for corporations. The Court then concluded that the residence of a trust should be determined based on residency of the trustees.
Just over thirty years later, we now have a different opinion from the Tax Court regarding this issue. With the Garron Family Trust decision, the Court has now embraced the notion that the residence of a trust should be similar to that of a corporation. The Court will look to the management and control of the trust to determine residency of the trust. The Court concluded that adopting a similar test of residence for trusts and corporations promotes the important principles of consistency, predictability and fairness in the application of tax law.
With an update in the jurisprudence related to the residency of trusts, the Canada Revenue Agency (CRA) is now aggressively reviewing tax planning structures involving trusts to reduce tax avoidance through international and inter-provincial tax planning.
The CRA recently hired additional auditors to review the residency of Alberta trusts. During the past several years, it has been attractive and popular for individuals located in provinces other than Alberta to set up an Alberta resident trust to access Alberta's low provincial tax rates. With this review of Alberta Trusts, the CRA is seeking to determine the "management and control" over the trust assets. As a result, it has distributed questionnaires to Alberta trustees, requesting the following information:
•a list of the duties and responsibilities as the trustee;
•the signing and/or contracting authority of the trustees; and
•the responsibility of the trustees for the management of any business or property owned by the trust, the banking and financing arrangements for the trust, and the preparation of the trust's accounts and reporting to the beneficiaries.
If the CRA determines that the management and control over the trust assets rests with any person(s) other than the Alberta trustees, it may determine the residence of the trust to be other than Alberta and reassess the provincial taxes accordingly.
Based on the 2010 Federal Budget, and the Department of Finance's desire to close various loopholes in the Income Tax Act, and to try to find ways to generate revenue to assist in reducing the deficit, we can anticipate the CRA will also apply the same aggressive nature toward international tax planning strategies involving trusts.
This may be a new chapter in the taxation of trusts, but the story is not over yet. The Garron Family Trust has requested leave to appeal to the Federal Court of Appeal. We will have to wait for the outcome of that appeal to see whether a new chapter is written once again, or if the book is closed for the foreseeable future.
Thursday, August 26, 2010
Shifting taxable income to someone else? You still might foot the bill
Today I would share an excellent article written by Tim cesnick published in the Globe and Mail.
Shifting taxable income to someone else? You still might foot the bill.
Some things just seem a little backward. Take my cousin Julia’s situation for example. Julia is an environmentalist – a self-proclaimed “tree-hugger,” to use her words. Her husband is a competitive swimmer. She doesn’t shave her legs, but he shaves his. It just seems backward to me.
The folks at the Canada Revenue Agency (CRA) often take offence to things when they’re backward. No, I’m not talking about personal grooming habits – CRA doesn’t care much about whether or not you shave your legs. But CRA does care when someone else pays a tax bill and it should be you paying the tax instead.
The rules
Let me tell you about subsection 56(2) of our tax law, which can cause real problems in certain situations. Specifically, this subsection will cause certain amounts to be taxed in your hands even when the amounts were received by someone else. Subsection 56(2) applies when the following conditions are met:
1. There is a payment or a transfer of property to a person other than you.
2. This payment is made at your direction, or with your concurrence.
3. There is a benefit to you, or a benefit you wish to confer on the other person.
4. You would have been taxable on the amount had you received the payment or transfer of property.
In situations where these conditions are met, subsection 56(2) will cause the amount to be taxed in your hands rather than the hands of the other person who received the amount. If subsection 56(2) applies, the amount in question will need to be added to your income; CRA will however reduce the income of the person who initially received the amount, in order to prevent double taxation.
The examples
Clear as mud so far? Let me share a few examples where 56(2) might apply.
* Sale of an asset. If you sell an asset but direct the sale proceeds to be paid to your spouse or a family member with the hope that they’ll pay the tax instead, 56(2) could apply to cause you to pay the tax anyway.
* Business income. Perhaps you own a business, provide goods and/or services to a customer, and then direct the customer to make payment to your spouse or family member and not you. Beware of 56(2).
* Rental income. If you own a rental property, or part thereof, and you instruct a tenant to make payment to your spouse, child, a charity, or some other party, subsection 56(2) could apply.
* Employment income. As an employee you could be subject to 56(2) if your employer makes a payment to one of your family members for services provided by you.
* Gifts by a corporation. Perhaps you’re a shareholder and the corporation makes a gift of cash or property to one of your family members. Subsection 56(2) could apply to tax you on the value of the gift because the gift would likely have been taxable to you as a shareholder benefit had it been made to you.
* Property sold to family. If you’re a shareholder and your corporation sells an asset to a family member at an amount below fair market value subsection, 56(2) could apply.
* Dividends paid to shareholders. Consider a situation where dividends are paid to a shareholder who is not entitled to receive dividends and/or you had a pre-existing right to dividends. Or where you might waive your dividend entitlement for the purpose of transferring income to other shareholders. Subsection 56(2) could apply to tax you on those amounts.
Now you get the drift. Subsection 56(2) is not to be confused with the other attribution rules in our tax law that can cause investment income to be taxed in your hands when you give or lend investment assets to a family member. This provision is broader. It can even apply to tax you on payments made to unrelated third parties.
The solutions
You should note that there’s often a way to accomplish the same tax savings without triggering 56(2).
This might mean receiving a payment yourself and then paying a deductible amount to a family member, properly transferring an asset to your spouse or child to allow them to pay tax on a sale later, restructuring your employment contract to allow payments to an assistant who might be a family member, or revising the terms of your company’s share classes to allow a more flexible sprinkling of dividends, among other ideas.
It’s also worth noting that there’s an exception for the splitting of CPP benefits, which is specifically allowed under our tax law.
Shifting taxable income to someone else? You still might foot the bill.
Some things just seem a little backward. Take my cousin Julia’s situation for example. Julia is an environmentalist – a self-proclaimed “tree-hugger,” to use her words. Her husband is a competitive swimmer. She doesn’t shave her legs, but he shaves his. It just seems backward to me.
The folks at the Canada Revenue Agency (CRA) often take offence to things when they’re backward. No, I’m not talking about personal grooming habits – CRA doesn’t care much about whether or not you shave your legs. But CRA does care when someone else pays a tax bill and it should be you paying the tax instead.
The rules
Let me tell you about subsection 56(2) of our tax law, which can cause real problems in certain situations. Specifically, this subsection will cause certain amounts to be taxed in your hands even when the amounts were received by someone else. Subsection 56(2) applies when the following conditions are met:
1. There is a payment or a transfer of property to a person other than you.
2. This payment is made at your direction, or with your concurrence.
3. There is a benefit to you, or a benefit you wish to confer on the other person.
4. You would have been taxable on the amount had you received the payment or transfer of property.
In situations where these conditions are met, subsection 56(2) will cause the amount to be taxed in your hands rather than the hands of the other person who received the amount. If subsection 56(2) applies, the amount in question will need to be added to your income; CRA will however reduce the income of the person who initially received the amount, in order to prevent double taxation.
The examples
Clear as mud so far? Let me share a few examples where 56(2) might apply.
* Sale of an asset. If you sell an asset but direct the sale proceeds to be paid to your spouse or a family member with the hope that they’ll pay the tax instead, 56(2) could apply to cause you to pay the tax anyway.
* Business income. Perhaps you own a business, provide goods and/or services to a customer, and then direct the customer to make payment to your spouse or family member and not you. Beware of 56(2).
* Rental income. If you own a rental property, or part thereof, and you instruct a tenant to make payment to your spouse, child, a charity, or some other party, subsection 56(2) could apply.
* Employment income. As an employee you could be subject to 56(2) if your employer makes a payment to one of your family members for services provided by you.
* Gifts by a corporation. Perhaps you’re a shareholder and the corporation makes a gift of cash or property to one of your family members. Subsection 56(2) could apply to tax you on the value of the gift because the gift would likely have been taxable to you as a shareholder benefit had it been made to you.
* Property sold to family. If you’re a shareholder and your corporation sells an asset to a family member at an amount below fair market value subsection, 56(2) could apply.
* Dividends paid to shareholders. Consider a situation where dividends are paid to a shareholder who is not entitled to receive dividends and/or you had a pre-existing right to dividends. Or where you might waive your dividend entitlement for the purpose of transferring income to other shareholders. Subsection 56(2) could apply to tax you on those amounts.
Now you get the drift. Subsection 56(2) is not to be confused with the other attribution rules in our tax law that can cause investment income to be taxed in your hands when you give or lend investment assets to a family member. This provision is broader. It can even apply to tax you on payments made to unrelated third parties.
The solutions
You should note that there’s often a way to accomplish the same tax savings without triggering 56(2).
This might mean receiving a payment yourself and then paying a deductible amount to a family member, properly transferring an asset to your spouse or child to allow them to pay tax on a sale later, restructuring your employment contract to allow payments to an assistant who might be a family member, or revising the terms of your company’s share classes to allow a more flexible sprinkling of dividends, among other ideas.
It’s also worth noting that there’s an exception for the splitting of CPP benefits, which is specifically allowed under our tax law.
Sunday, August 15, 2010
Business Owners: Did you ever use some income splitting techniques?
below is a great article written by BDO Canada, Chartered Accountants.
Family income splitting
The following opportunities exist to split income with other members of your family:
Make an interest-free loan to your spouse or children for investment purposes.
Under the attribution rules, income earned by your spouse or child on the funds will be taxed in your hands, just as it would have been had you not made the loan. However, that income becomes their property and can be reinvested without further attribution. Over time, family members can build up a large pool of funds which earn income taxed in their hands. Be sure to deposit the income in a separate bank account so that it can be properly tracked and separated from the funds advanced as a loan. Also, you may want to consider setting up a trust to manage the funds if minor children are involved.
The attribution rules do not apply to loans that bear interest at the prescribed rate—an interest rate set quarterly by the Canada Revenue Agency (CRA) that approximates short-term Treasury Bill rates. If you loan funds to your spouse or child and the funds are invested so that the rate of return is higher than the prescribed rate, the excess income will be taxed in their hands. Note that interest on the loan must be paid no later than 30 days after the end of the year. Where the interest is not paid on time once, the loan will be subject to the attribution rules until repaid. The interest rate on the loan does not have to be adjusted each time the prescribed rate changes.
Loan funds to family members other than your spouse to invest in assets that produce capital gains.
Consider loaning funds interest-free to low-income family members other than your spouse. They can use the funds to purchase investments with low returns, but with the potential to produce capital gains. Capital gains arising on these investments will not be subject to attribution.
Many mutual funds invest in growth stocks with low dividend rates. Such investments are well-suited for this plan, as any distribution from these funds are often a distribution of capital gains.
If a child’s in-trust account or a trust for the child has investments with accrued gains, consider triggering these gains each year to the extent the child’s personal exemptions are not otherwise utilized. This will help ensure that the child won’t have a large gain that will be taxed at some point in the future.
Make gifts to adult family members.
If you support adult family members, such as children at university or elderly parents, consider giving them assets which they can invest to earn their own income. The income will be taxed in their hands, not yours, and they’ll have more after-tax funds than if you had earned the income and paid their expenses.
This situation can arise where an adult child needs money for his or her education, or where your parents are dependent on you for support. Bear in mind that a gift means you give up control of the asset. If making gifts to low-income parents, you may want to ensure that the assets will be left to you in their wills. Also, if you give property other than cash to any relative, you’re deemed to dispose of it at fair market value, which could result in a taxable capital gain.
Ensure the high-income spouse pays all family expenses, while the low-income spouse saves.
Often, both spouses contribute equally to household expenses, where each have a source of income. This may seem fair and reasonable, but it’s poor tax planning. To the maximum extent possible, the low-income spouse’s salary and other earnings should be saved for investment purposes, while the higher income spouse pays for expenses such as food, clothing, mortgage payments etc. You can even pay your spouse’s taxes. This ensures that the family’s total investment income is taxed at the lowest possible rate.
Loan or give funds to family members to purchase a principal residence.
If you support a child in residence at university or pay rent for elderly parents, consider loaning or giving them funds to purchase a separate residence. This will reduce your investment income subject to tax and, since the funds aren’t earning income, there’s no attribution. Also, if the property increases in value, the family member may be able to use the principal residence exemption.
Invest the Child Tax Benefit and the Universal Child Care Benefit in the name of your children.
The Child Tax Benefit is based on family income. Consequently, higher income families do not qualify for the benefit. The Universal Child Care Benefit is available to all parents for children under the age of six and is paid in instalments of $100 per month per child. To the extent that you receive these benefits, you should invest the funds in a separate account in trust for your children. Investment income on these funds will not be attributed to you.
Invest inheritances for the benefit of your children.
If your child inherits money, make sure that you segregate these funds and invest them in the name of the child. If you or your spouse will inherit funds from a relative you can split income from that inheritance as well, if your relative names your child as a beneficiary. Keep in mind that if a child’s inheritance from a relative, that is not their parent, includes shares of a private company, the dividends will likely be subject to the kiddie tax (which we discuss later in the section entitled “Income splitting through corporations”).
Treat educational support to your spouse as a loan.
If you’re supporting your spouse while he or she is in attendance at a school, college or university and the spouse is expected to eventually be the high-income earner, treat the amounts spent on his or her education as a loan. Later, when the individual earns income, the amount can be repaid to you for investment purposes. You should document the amounts spent and have a written loan agreement.
Shift assets between spouses.
The attribution rules don’t apply if you transfer assets to your spouse in return for assets of equal value. If your spouse has non-income-producing property (i.e. such as a cottage), consider purchasing these assets for cash (or other income-producing assets) at their fair market value. You and your spouse can continue to enjoy the assets, as your spouse earns income from the funds.
Usually, assets can be exchanged between spouses with no tax consequences. However, to avoid attribution, you and your spouse must elect to have the sale occur at fair market value. If the assets transferred have accrued gains, a capital gain will result. If the election is made, any future income or capital gains on the income-producing property would not be attributed back to the transferring spouse.
Contribute to a Registered Education Savings Plan (RESP).
An RESP is a vehicle through which you can defer taxes, split income with your children and save towards their post-secondary education all at the same time. Unlike a Registered Retirement Savings Plan (RRSP), contributions to the plan are not deductible. However, income earned in the plan is not taxed until distributed as educational assistance payments to someone named by you as a beneficiary under the plan. At such time, the income is taxable in the hands of the recipient, presumably at a lower rate, and the original contributions are returned tax-free.
Before the 2007 Federal budget, you were allowed to contribute up to $4,000 annually to an RESP – with a cumulative lifetime contribution limit of $42,000. Changes announced in the 2007 Federal budget eliminated the $4,000 annual RESP contribution limit and the lifetime RESP contribution limit was increased to $50,000. What this means is that you can contribute $50,000 immediately to an RESP. Note that if more than one plan has been set up for a particular beneficiary, you and the other contributors must share the contribution limit. The plan itself must be wound up after 25 years.
There are two types of plans—individual plans and group plans. In addition, there are two kinds of individual plans – non-family plans and family plans. A non-family plan is a plan you set up for just one beneficiary, and there are no restrictions on who can be a beneficiary of such plan. A family plan can have more than one beneficiary; however, each beneficiary must be connected by blood or adoption to each living subscriber under the plan or have been connected to a deceased original subscriber.
A group plan (also referred to as a pooled plan or a scholarship plan), is a set of individual non-family plans that are administered based on a specific age group. Individual plans are more flexible, as they give the contributor more control over the investments made and the timing and amount of educational assistance payments made to beneficiaries. It is important to review all plans carefully to fully understand the provisions of the plan in the event that beneficiaries do not attend college or university within the required time period.
An added benefit of using an RESP is the Canada Education Savings Grant (CESG). The CESG is a federal grant that is added to your eligible contributions. Changes in the 2007 Federal budget increased the maximum annual RESP contribution qualifying for the 20% CESG to $2,500 from $2,000, which increases the maximum annual CESG per beneficiary for 2007 and subsequent years to $500 from $400. Similarly, the maximum CESG for a year has been increased to $1,000 from $800 if there is unused grant room because of contributions of less than the maximum amount in previous years. It is worth noting that the $7,200 lifetime CESG limit is unaffected by these changes.
Despite these beneficial changes, it may still make sense to use both an RESP and an “in-trust” account when saving for a child’s education. For more information, see Are You Getting a Passing Grade on Education Savings? in the 2008-01 issue of The Tax Factor.
Pay your spouse’s interest-bearing debts.
If your spouse has incurred interest-bearing debts such as a car loan, consider paying off these debts on behalf of your spouse. The reduction in interest expense is not subject to attribution. Your spouse will then have more funds to invest in the future.
Note that this plan does not work if the debts were incurred to acquire income-producing properties. If you pay off these debts, any income from the properties will attribute to you.
Provide for a testamentary trust in your will.
Rather than leaving your estate directly to your spouse, children or other dependants, consider leaving some funds in a testamentary trust for the benefit of these individuals. A testamentary trust pays tax as though it were an individual. Income from the funds will be taxed in the trust and will thereby benefit from an additional set of lower marginal tax rates. It is even possible to set up multiple testamentary trusts under your will, one for each beneficiary, which can multiply the availability of lower marginal tax rates on the income earned by the assets in your estate. The capital and after-tax income can be distributed over time to your beneficiaries free of tax. Your BDO advisor can help you select the method which best suits your needs and can assist you in other areas of estate planning.
Business income splitting
If you carry on a business, other income splitting opportunities are available to you:
Make your spouse a partner of your unincorporated business.
If you operate an unincorporated business in which your spouse is active, you may be able to establish that he or she is your partner, eligible to share in the profits or losses of the business. To be considered a bona fide partner, your spouse must either devote a significant amount of his or her time, specified skills, or training to the business or must have invested his or her own property in the business. You must ensure that your spouse’s share of income is reasonable compared with the amount of work or capital put into the business. A partnership agreement is recommended.
Pay your spouse and children a salary.
If your spouse or children work in your business, consider paying them a salary. The salary must be reasonable given the services performed. A good rule of thumb is to pay them what you would have paid a third party for the same services. A record should be kept of the time actually spent and the services actually performed.
When you pay salaries to your spouse or children, you usually must make withholdings for income tax, Canada/Quebec Pension Plan (for individuals over 18 years of age) and any applicable provincial payroll taxes. There will generally be no liability for employment insurance on remuneration paid to members of your family.
Pay your spouse a director’s fee.
If your spouse is a director of your corporation, consider paying your spouse a director’s fee for services performed. A director’s services usually include attending directors’ meetings, directing the management and affairs of the business, approving financial statements, declaring dividends, approving changes to share capital and electing officers of the company. Note that your spouse will also be jointly liable with the other directors for the fulfillment of certain regulatory requirements, such as salary withholdings and GST collections.
Pay a guarantee fee to your spouse.
If your spouse is required to pledge assets or to otherwise guarantee a business loan, he or she can be paid a fee by the business.
Again, the amount paid must be reasonable in the circumstances. In determining reasonableness, one would look at the amount of the loan, subsequent ability of the business to repay the loan and the amount that would have otherwise been paid to an arm’s-length party to guarantee the loan. The fee will also help in establishing deductibility of the loan for your spouse, should the debt become bad and the guarantee ever be called.
Loan funds to your spouse to start-up a business.
Only income from property is subject to attribution. Income from a business is not. If your spouse has a promising business venture, you can provide interest-free financing without any attribution. If the venture is risky, you should consider that an interest-free loan would not qualify for capital loss treatment should the venture fail. If this is the case, you might want to make a capital contribution to the business as a partner and share in the start-up loss. When the business becomes profitable, you can make interest-free loans to the business for further expansion. A gift could also be used to finance a new venture. Your spouse’s share of profits from the venture can be invested by your spouse and would not be subject to income attribution.
Income splitting through corporations
In the past, income splitting was possible with all members of your family through your corporation by issuing shares to your spouse and children, as long as you were careful to overcome certain obstacles. Dividends paid by the corporation to the shareholders would be taxed in their hands, provided you did not give or loan them the funds interest-free to acquire the shares. However, with the introduction of the kiddie tax, the government created yet another obstacle when it comes to income splitting with minor children. In order to implement a corporate income splitting plan that is successful, you must be aware of all of the obstacles that prevent income splitting.
The first obstacle is a set of rules commonly referred to as the corporate attribution rules. Without these rules, you could avoid attribution by simply making interest-free loans to a corporation where your spouse and children are shareholders, instead of directly to them. The corporate attribution rules provide that, if you make a low-interest or interest-free loan or transfer any property to a corporation with the main purpose of reducing your income and benefiting your spouse or minor children, you are deemed to receive interest on the loan or the value of the property transferred at the CRA’s prescribed rate. This income inclusion to you is reduced by any interest, by 5/4ths of any ineligible dividends and 145% of any eligible dividends you actually receive from the corporation. This deemed interest arises even if no income is earned by the corporation and no dividends are paid to your spouse or children. Consequently, it is a penalty provision that should be avoided.
The rules do not apply during any period that the corporation is a small business corporation (SBC). An SBC is a Canadian-controlled private corporation (CCPC) in which at least 90% of the assets (on a fair market value basis) are used in operating an active business in Canada. Therefore, as long as your corporation carries on business and does not accumulate significant investment assets, your spouse and children, particularly those 18 years of age and older, can be a shareholder and receive dividends.
The second obstacle is the kiddie tax, which prevents the transfer of income from high-income individuals to their children under the age of 18. Rather than redirecting income and taxing it in the hands of the high-income family member, the rules provide for a tax on minors who receive income under an income splitting arrangement.
Beginning in the year 2000, minor children are taxed at the top federal personal tax rate on dividends or business income received from a family business.
Specifically, this tax will apply on the following sources of income:
Taxable dividends received directly by a minor, or indirectly through a trust or partnership. Dividends from publicly traded corporations are excluded.
Income inclusions required under the Income Tax Act, in respect of the ownership by any person of shares of the capital stock of a corporation. Shares of a class listed on a prescribed stock exchange are excluded.
Business income from a partnership or trust, where the income is from property (prior to 2003, this reference was to goods) or services provided to, or in support of, a business carried on by:
a person related to the minor, including a relative who is a partner of the partnership earning business income, a corporation where a relative of the minor owns 10% or more of the corporation’s shares, or a professional corporation where a relative of the minor is a shareholder.
The reference to business income earned in support of another business carried on by a relative appears to be designed to prevent you from having your management company or partnership bill third parties directly, rather than your own business, for services rendered. Generally effective for 2003 and subsequent years, the government has proposed to extend the income splitting tax to catch rental or interest income earned by a trust or partnership from a family business and received by minor children.
Personal tax credits cannot be claimed to reduce this tax. However, the minor will be allowed to claim the dividend tax credits and foreign tax credits, where applicable, to reduce the tax.
Although limited, there are some exceptions to the kiddie tax:
the tax will not apply where both of the minor’s parents are non-residents of Canada, the tax will not apply on income from property inherited from a parent, and
if the child is going to college or university, or is disabled, income from property inherited from others won’t be subject to the tax. With the tax on minor children, it is difficult to achieve business income splitting through a corporation with minor children. However, income splitting with your spouse and children who are 18 years of age and older is alive and well. In a typical corporate income splitting arrangement, shares with nominal value are issued to the spouse and children. Dividends are later paid on these shares as income is earned by the corporation. The dividends paid often exceed the amount paid for the shares. Since different classes of shares are usually issued to different family members, it’s possible to determine the dividend amount to each person to minimize tax. (Note that the dividends paid to minor children will now be subject to the income splitting tax.)
This process, called “dividend sprinkling”, was the subject of a 1990 Supreme Court case (The Queen v. McClurg). The following guidelines were drawn from the outcome of that case:
1.If you’re setting up multiple classes of shares, you should ensure each class is different in some respect from the others—for example, one class of shares can be voting while the others are not, some shares can share in growth while other shares are redeemable at a set price. By varying the attributes of the shares, it is possible to have several unique classes of shares.
2.Fair market value consideration must be paid by your family members in exchange for the shares issued. This may be difficult if the shares have high value and the family members have no independent source of funds. Income splitting arrangements are often accompanied by a “freeze” in the value of the company. This is accomplished by having the owner-manager exchange their common shares for preferred shares having a redemption amount equal to the value of the company. Provided the preferred shares have attributes that support this fair market value, any new common shares issued should then have only a nominal value.
3.Each shareholder should pay for the shares using his or her own funds and not funds provided by the owner-manager.
If you have an existing income splitting plan that involves minor children, the kiddie tax will generally now make the payment of dividends to these children unattractive. The best way to optimize your current income splitting plan is to reinvest as much money as possible, that was accumulated in the past under your plan, for the benefit of your child. Your BDO advisor also has other more sophisticated income splitting strategies that might make sense for you.
Corporate income splitting is still very much an option with your spouse and children who are 18 years of age and older. Remember to consider the corporate attribution rules where a spouse will be a shareholder. Great care is required when developing a corporate income splitting plan and your BDO tax advisor should be consulted prior to undertaking any arrangement.
Family income splitting
The following opportunities exist to split income with other members of your family:
Make an interest-free loan to your spouse or children for investment purposes.
Under the attribution rules, income earned by your spouse or child on the funds will be taxed in your hands, just as it would have been had you not made the loan. However, that income becomes their property and can be reinvested without further attribution. Over time, family members can build up a large pool of funds which earn income taxed in their hands. Be sure to deposit the income in a separate bank account so that it can be properly tracked and separated from the funds advanced as a loan. Also, you may want to consider setting up a trust to manage the funds if minor children are involved.
The attribution rules do not apply to loans that bear interest at the prescribed rate—an interest rate set quarterly by the Canada Revenue Agency (CRA) that approximates short-term Treasury Bill rates. If you loan funds to your spouse or child and the funds are invested so that the rate of return is higher than the prescribed rate, the excess income will be taxed in their hands. Note that interest on the loan must be paid no later than 30 days after the end of the year. Where the interest is not paid on time once, the loan will be subject to the attribution rules until repaid. The interest rate on the loan does not have to be adjusted each time the prescribed rate changes.
Loan funds to family members other than your spouse to invest in assets that produce capital gains.
Consider loaning funds interest-free to low-income family members other than your spouse. They can use the funds to purchase investments with low returns, but with the potential to produce capital gains. Capital gains arising on these investments will not be subject to attribution.
Many mutual funds invest in growth stocks with low dividend rates. Such investments are well-suited for this plan, as any distribution from these funds are often a distribution of capital gains.
If a child’s in-trust account or a trust for the child has investments with accrued gains, consider triggering these gains each year to the extent the child’s personal exemptions are not otherwise utilized. This will help ensure that the child won’t have a large gain that will be taxed at some point in the future.
Make gifts to adult family members.
If you support adult family members, such as children at university or elderly parents, consider giving them assets which they can invest to earn their own income. The income will be taxed in their hands, not yours, and they’ll have more after-tax funds than if you had earned the income and paid their expenses.
This situation can arise where an adult child needs money for his or her education, or where your parents are dependent on you for support. Bear in mind that a gift means you give up control of the asset. If making gifts to low-income parents, you may want to ensure that the assets will be left to you in their wills. Also, if you give property other than cash to any relative, you’re deemed to dispose of it at fair market value, which could result in a taxable capital gain.
Ensure the high-income spouse pays all family expenses, while the low-income spouse saves.
Often, both spouses contribute equally to household expenses, where each have a source of income. This may seem fair and reasonable, but it’s poor tax planning. To the maximum extent possible, the low-income spouse’s salary and other earnings should be saved for investment purposes, while the higher income spouse pays for expenses such as food, clothing, mortgage payments etc. You can even pay your spouse’s taxes. This ensures that the family’s total investment income is taxed at the lowest possible rate.
Loan or give funds to family members to purchase a principal residence.
If you support a child in residence at university or pay rent for elderly parents, consider loaning or giving them funds to purchase a separate residence. This will reduce your investment income subject to tax and, since the funds aren’t earning income, there’s no attribution. Also, if the property increases in value, the family member may be able to use the principal residence exemption.
Invest the Child Tax Benefit and the Universal Child Care Benefit in the name of your children.
The Child Tax Benefit is based on family income. Consequently, higher income families do not qualify for the benefit. The Universal Child Care Benefit is available to all parents for children under the age of six and is paid in instalments of $100 per month per child. To the extent that you receive these benefits, you should invest the funds in a separate account in trust for your children. Investment income on these funds will not be attributed to you.
Invest inheritances for the benefit of your children.
If your child inherits money, make sure that you segregate these funds and invest them in the name of the child. If you or your spouse will inherit funds from a relative you can split income from that inheritance as well, if your relative names your child as a beneficiary. Keep in mind that if a child’s inheritance from a relative, that is not their parent, includes shares of a private company, the dividends will likely be subject to the kiddie tax (which we discuss later in the section entitled “Income splitting through corporations”).
Treat educational support to your spouse as a loan.
If you’re supporting your spouse while he or she is in attendance at a school, college or university and the spouse is expected to eventually be the high-income earner, treat the amounts spent on his or her education as a loan. Later, when the individual earns income, the amount can be repaid to you for investment purposes. You should document the amounts spent and have a written loan agreement.
Shift assets between spouses.
The attribution rules don’t apply if you transfer assets to your spouse in return for assets of equal value. If your spouse has non-income-producing property (i.e. such as a cottage), consider purchasing these assets for cash (or other income-producing assets) at their fair market value. You and your spouse can continue to enjoy the assets, as your spouse earns income from the funds.
Usually, assets can be exchanged between spouses with no tax consequences. However, to avoid attribution, you and your spouse must elect to have the sale occur at fair market value. If the assets transferred have accrued gains, a capital gain will result. If the election is made, any future income or capital gains on the income-producing property would not be attributed back to the transferring spouse.
Contribute to a Registered Education Savings Plan (RESP).
An RESP is a vehicle through which you can defer taxes, split income with your children and save towards their post-secondary education all at the same time. Unlike a Registered Retirement Savings Plan (RRSP), contributions to the plan are not deductible. However, income earned in the plan is not taxed until distributed as educational assistance payments to someone named by you as a beneficiary under the plan. At such time, the income is taxable in the hands of the recipient, presumably at a lower rate, and the original contributions are returned tax-free.
Before the 2007 Federal budget, you were allowed to contribute up to $4,000 annually to an RESP – with a cumulative lifetime contribution limit of $42,000. Changes announced in the 2007 Federal budget eliminated the $4,000 annual RESP contribution limit and the lifetime RESP contribution limit was increased to $50,000. What this means is that you can contribute $50,000 immediately to an RESP. Note that if more than one plan has been set up for a particular beneficiary, you and the other contributors must share the contribution limit. The plan itself must be wound up after 25 years.
There are two types of plans—individual plans and group plans. In addition, there are two kinds of individual plans – non-family plans and family plans. A non-family plan is a plan you set up for just one beneficiary, and there are no restrictions on who can be a beneficiary of such plan. A family plan can have more than one beneficiary; however, each beneficiary must be connected by blood or adoption to each living subscriber under the plan or have been connected to a deceased original subscriber.
A group plan (also referred to as a pooled plan or a scholarship plan), is a set of individual non-family plans that are administered based on a specific age group. Individual plans are more flexible, as they give the contributor more control over the investments made and the timing and amount of educational assistance payments made to beneficiaries. It is important to review all plans carefully to fully understand the provisions of the plan in the event that beneficiaries do not attend college or university within the required time period.
An added benefit of using an RESP is the Canada Education Savings Grant (CESG). The CESG is a federal grant that is added to your eligible contributions. Changes in the 2007 Federal budget increased the maximum annual RESP contribution qualifying for the 20% CESG to $2,500 from $2,000, which increases the maximum annual CESG per beneficiary for 2007 and subsequent years to $500 from $400. Similarly, the maximum CESG for a year has been increased to $1,000 from $800 if there is unused grant room because of contributions of less than the maximum amount in previous years. It is worth noting that the $7,200 lifetime CESG limit is unaffected by these changes.
Despite these beneficial changes, it may still make sense to use both an RESP and an “in-trust” account when saving for a child’s education. For more information, see Are You Getting a Passing Grade on Education Savings? in the 2008-01 issue of The Tax Factor.
Pay your spouse’s interest-bearing debts.
If your spouse has incurred interest-bearing debts such as a car loan, consider paying off these debts on behalf of your spouse. The reduction in interest expense is not subject to attribution. Your spouse will then have more funds to invest in the future.
Note that this plan does not work if the debts were incurred to acquire income-producing properties. If you pay off these debts, any income from the properties will attribute to you.
Provide for a testamentary trust in your will.
Rather than leaving your estate directly to your spouse, children or other dependants, consider leaving some funds in a testamentary trust for the benefit of these individuals. A testamentary trust pays tax as though it were an individual. Income from the funds will be taxed in the trust and will thereby benefit from an additional set of lower marginal tax rates. It is even possible to set up multiple testamentary trusts under your will, one for each beneficiary, which can multiply the availability of lower marginal tax rates on the income earned by the assets in your estate. The capital and after-tax income can be distributed over time to your beneficiaries free of tax. Your BDO advisor can help you select the method which best suits your needs and can assist you in other areas of estate planning.
Business income splitting
If you carry on a business, other income splitting opportunities are available to you:
Make your spouse a partner of your unincorporated business.
If you operate an unincorporated business in which your spouse is active, you may be able to establish that he or she is your partner, eligible to share in the profits or losses of the business. To be considered a bona fide partner, your spouse must either devote a significant amount of his or her time, specified skills, or training to the business or must have invested his or her own property in the business. You must ensure that your spouse’s share of income is reasonable compared with the amount of work or capital put into the business. A partnership agreement is recommended.
Pay your spouse and children a salary.
If your spouse or children work in your business, consider paying them a salary. The salary must be reasonable given the services performed. A good rule of thumb is to pay them what you would have paid a third party for the same services. A record should be kept of the time actually spent and the services actually performed.
When you pay salaries to your spouse or children, you usually must make withholdings for income tax, Canada/Quebec Pension Plan (for individuals over 18 years of age) and any applicable provincial payroll taxes. There will generally be no liability for employment insurance on remuneration paid to members of your family.
Pay your spouse a director’s fee.
If your spouse is a director of your corporation, consider paying your spouse a director’s fee for services performed. A director’s services usually include attending directors’ meetings, directing the management and affairs of the business, approving financial statements, declaring dividends, approving changes to share capital and electing officers of the company. Note that your spouse will also be jointly liable with the other directors for the fulfillment of certain regulatory requirements, such as salary withholdings and GST collections.
Pay a guarantee fee to your spouse.
If your spouse is required to pledge assets or to otherwise guarantee a business loan, he or she can be paid a fee by the business.
Again, the amount paid must be reasonable in the circumstances. In determining reasonableness, one would look at the amount of the loan, subsequent ability of the business to repay the loan and the amount that would have otherwise been paid to an arm’s-length party to guarantee the loan. The fee will also help in establishing deductibility of the loan for your spouse, should the debt become bad and the guarantee ever be called.
Loan funds to your spouse to start-up a business.
Only income from property is subject to attribution. Income from a business is not. If your spouse has a promising business venture, you can provide interest-free financing without any attribution. If the venture is risky, you should consider that an interest-free loan would not qualify for capital loss treatment should the venture fail. If this is the case, you might want to make a capital contribution to the business as a partner and share in the start-up loss. When the business becomes profitable, you can make interest-free loans to the business for further expansion. A gift could also be used to finance a new venture. Your spouse’s share of profits from the venture can be invested by your spouse and would not be subject to income attribution.
Income splitting through corporations
In the past, income splitting was possible with all members of your family through your corporation by issuing shares to your spouse and children, as long as you were careful to overcome certain obstacles. Dividends paid by the corporation to the shareholders would be taxed in their hands, provided you did not give or loan them the funds interest-free to acquire the shares. However, with the introduction of the kiddie tax, the government created yet another obstacle when it comes to income splitting with minor children. In order to implement a corporate income splitting plan that is successful, you must be aware of all of the obstacles that prevent income splitting.
The first obstacle is a set of rules commonly referred to as the corporate attribution rules. Without these rules, you could avoid attribution by simply making interest-free loans to a corporation where your spouse and children are shareholders, instead of directly to them. The corporate attribution rules provide that, if you make a low-interest or interest-free loan or transfer any property to a corporation with the main purpose of reducing your income and benefiting your spouse or minor children, you are deemed to receive interest on the loan or the value of the property transferred at the CRA’s prescribed rate. This income inclusion to you is reduced by any interest, by 5/4ths of any ineligible dividends and 145% of any eligible dividends you actually receive from the corporation. This deemed interest arises even if no income is earned by the corporation and no dividends are paid to your spouse or children. Consequently, it is a penalty provision that should be avoided.
The rules do not apply during any period that the corporation is a small business corporation (SBC). An SBC is a Canadian-controlled private corporation (CCPC) in which at least 90% of the assets (on a fair market value basis) are used in operating an active business in Canada. Therefore, as long as your corporation carries on business and does not accumulate significant investment assets, your spouse and children, particularly those 18 years of age and older, can be a shareholder and receive dividends.
The second obstacle is the kiddie tax, which prevents the transfer of income from high-income individuals to their children under the age of 18. Rather than redirecting income and taxing it in the hands of the high-income family member, the rules provide for a tax on minors who receive income under an income splitting arrangement.
Beginning in the year 2000, minor children are taxed at the top federal personal tax rate on dividends or business income received from a family business.
Specifically, this tax will apply on the following sources of income:
Taxable dividends received directly by a minor, or indirectly through a trust or partnership. Dividends from publicly traded corporations are excluded.
Income inclusions required under the Income Tax Act, in respect of the ownership by any person of shares of the capital stock of a corporation. Shares of a class listed on a prescribed stock exchange are excluded.
Business income from a partnership or trust, where the income is from property (prior to 2003, this reference was to goods) or services provided to, or in support of, a business carried on by:
a person related to the minor, including a relative who is a partner of the partnership earning business income, a corporation where a relative of the minor owns 10% or more of the corporation’s shares, or a professional corporation where a relative of the minor is a shareholder.
The reference to business income earned in support of another business carried on by a relative appears to be designed to prevent you from having your management company or partnership bill third parties directly, rather than your own business, for services rendered. Generally effective for 2003 and subsequent years, the government has proposed to extend the income splitting tax to catch rental or interest income earned by a trust or partnership from a family business and received by minor children.
Personal tax credits cannot be claimed to reduce this tax. However, the minor will be allowed to claim the dividend tax credits and foreign tax credits, where applicable, to reduce the tax.
Although limited, there are some exceptions to the kiddie tax:
the tax will not apply where both of the minor’s parents are non-residents of Canada, the tax will not apply on income from property inherited from a parent, and
if the child is going to college or university, or is disabled, income from property inherited from others won’t be subject to the tax. With the tax on minor children, it is difficult to achieve business income splitting through a corporation with minor children. However, income splitting with your spouse and children who are 18 years of age and older is alive and well. In a typical corporate income splitting arrangement, shares with nominal value are issued to the spouse and children. Dividends are later paid on these shares as income is earned by the corporation. The dividends paid often exceed the amount paid for the shares. Since different classes of shares are usually issued to different family members, it’s possible to determine the dividend amount to each person to minimize tax. (Note that the dividends paid to minor children will now be subject to the income splitting tax.)
This process, called “dividend sprinkling”, was the subject of a 1990 Supreme Court case (The Queen v. McClurg). The following guidelines were drawn from the outcome of that case:
1.If you’re setting up multiple classes of shares, you should ensure each class is different in some respect from the others—for example, one class of shares can be voting while the others are not, some shares can share in growth while other shares are redeemable at a set price. By varying the attributes of the shares, it is possible to have several unique classes of shares.
2.Fair market value consideration must be paid by your family members in exchange for the shares issued. This may be difficult if the shares have high value and the family members have no independent source of funds. Income splitting arrangements are often accompanied by a “freeze” in the value of the company. This is accomplished by having the owner-manager exchange their common shares for preferred shares having a redemption amount equal to the value of the company. Provided the preferred shares have attributes that support this fair market value, any new common shares issued should then have only a nominal value.
3.Each shareholder should pay for the shares using his or her own funds and not funds provided by the owner-manager.
If you have an existing income splitting plan that involves minor children, the kiddie tax will generally now make the payment of dividends to these children unattractive. The best way to optimize your current income splitting plan is to reinvest as much money as possible, that was accumulated in the past under your plan, for the benefit of your child. Your BDO advisor also has other more sophisticated income splitting strategies that might make sense for you.
Corporate income splitting is still very much an option with your spouse and children who are 18 years of age and older. Remember to consider the corporate attribution rules where a spouse will be a shareholder. Great care is required when developing a corporate income splitting plan and your BDO tax advisor should be consulted prior to undertaking any arrangement.
Monday, February 15, 2010
What is Income Splitting ??
Canada has a progressive income tax system - the more you earn the higher the rate of tax which you pay. Income splitting is a family tax planning technique designed to shift income from a high rate taxpayer to a lower rate taxpayer such as a spouse or children.
A number of different techniques can be used to accomplish this objective. However, you must be careful because Revenue Canada frowns on income splitting and there are provisions in the Income Tax Act designed to curtail it.
please contact me to see if you can benefit from this tax planning technique.
A number of different techniques can be used to accomplish this objective. However, you must be careful because Revenue Canada frowns on income splitting and there are provisions in the Income Tax Act designed to curtail it.
please contact me to see if you can benefit from this tax planning technique.
Do you qualify to split your pension income?
Do you qualify to split your pension income?
You (the Pensioner) and your spouse or common-law partner (the Pension Transferee) can elect to split your eligible pension income received in the year if you meet the following conditions:
- you are married or in a common-law partnership with each other in the year and are not, because of a breakdown in your marriage or common-law partnership, living separate and apart from each other at the end of the tax year and for a period of 90 days or more commencing in the year (see the note below); and
- you are are both resident in Canada on December 31 of the year; or
- if deceased in the year, resident in Canada on the date of death; or
- if bankrupt in the year, resident in Canada on December 31 of the year in which the tax year (pre- or post-bankruptcy) ends.
- you received pension income in the year that qualifies for the pension income amount.
* Note: You and your spouse or common-law partner will still be eligible to split pension income if living apart at the end of the year for medical, educational, or business reasons (rather than a breakdown in the marriage or common-law partnership).
Eligible pension income can only be split between you (the Pensioner) and your spouse or common-law partner (the Pension Transferee).
You are not prevented from splitting your eligible pension income because of the age of your spouse or common-law partner.
for more information, click here
You (the Pensioner) and your spouse or common-law partner (the Pension Transferee) can elect to split your eligible pension income received in the year if you meet the following conditions:
- you are married or in a common-law partnership with each other in the year and are not, because of a breakdown in your marriage or common-law partnership, living separate and apart from each other at the end of the tax year and for a period of 90 days or more commencing in the year (see the note below); and
- you are are both resident in Canada on December 31 of the year; or
- if deceased in the year, resident in Canada on the date of death; or
- if bankrupt in the year, resident in Canada on December 31 of the year in which the tax year (pre- or post-bankruptcy) ends.
- you received pension income in the year that qualifies for the pension income amount.
* Note: You and your spouse or common-law partner will still be eligible to split pension income if living apart at the end of the year for medical, educational, or business reasons (rather than a breakdown in the marriage or common-law partnership).
Eligible pension income can only be split between you (the Pensioner) and your spouse or common-law partner (the Pension Transferee).
You are not prevented from splitting your eligible pension income because of the age of your spouse or common-law partner.
for more information, click here
Tuesday, February 12, 2008
Some basic tax planning - income splitting
I met with an entrepreneur yesterday - great business - she's an owner-manager. Her business is picking up and the husband will now join her to expand into new market. After reviewing her minute book, I explained her that she had only one class of share. I further explained her that in order to maximize her income tax splitting, it would beneficial to change her share structure and to create several classes of shares. Her husband will acquired shares of a different class. The rational is that she would able to split the income between her husband and her by declaring a dividend to for each class of shares. By way of example, let's say that company XYZ have $100,000 in retained earning at the end of the year, the company could pay a dividend of $100,000 to the wife. However, with that new structure, the company could declare a dividend of $70,000 to the wife and $30,000 to the husband. Obviously, the income taxes to be paid would be quite different in these 2 scenarios. Please keep in mind that some special rules exist, such as the attribution rule, but if planned in conjonction with your accountant, these kind of strategy are more than worth it. I recommend you to consult your accountant and your lawyer to learn more.
Subscribe to:
Posts (Atom)