The top 20 per cent of Canadian income earners pay more than 61 per cent of the income tax, according to a Fraser Institute study from 2022. Today, the marginal tax rate in Ontario for those earning over $235,675 is 53.53 per cent.
Nevertheless, our prime minister said in 2017, “Everyone knows, the middle class pay too much in taxes and the wealthiest don’t pay enough.”
For those, who may not agree with him, let’s look at four ways wealthier Canadians might save on taxes so that they might only be paying something like five times instead of seven times what the average person pays.
For more than 50 years, the Canadian government has had a program to help support the mining industry by encouraging investment in exploration and development projects. This program allows Canadians to invest in shares that qualify for flow-through credits.
It benefits investors in two major ways. The first is that money invested in flow-through shares is deducted from your taxable income, just like registered retirement savings plan (RRSP) contributions. The second is that there are additional tax credits provided by the federal and provincial governments. The tax benefits are significant, especially for those who are paying marginal tax rates at the top bracket — usually more than 50 per cent.
One drawback with flow-through shares is that the shares you buy are considered to have a zero-cost base, so it creates capital gains. Even with this drawback, the tax on capital gains pales in comparison to the tax savings above. Having said that, if you have meaningful capital losses to carry forward, this makes flow-through shares an even better investment.
The other drawbacks are that you have to invest in shares of companies you might not otherwise want to invest in, and sometimes flow-through shares are purchased at a premium over the true market price of a stock.
This risk can be eliminated in some cases with specialized flow-through share programs that lock in the price of the stock. The net result is that there is certainty about the tax benefit to you overall, without the potential future gain or loss on the stock.
Life insurance purchased by your corporation
This is ideal for someone who has a holding company or professional corporation with a value of $1 million or more, especially if they are unlikely to spend these funds in their lifetime.
Like an RRSP or registered retirement income fund (RRIF), money in a corporation is taxed when withdrawn. Unlike the RRSP or RRIF, the income earned in the corporation is taxed fairly highly if it is considered passive (generally considered to be income earned through minimum labour).
Some wealthier Canadians have managed to build up funds in their corporations, but are able to access money more tax efficiently from other places. The challenge is that the income on those funds is taxed highly in the corporation and, ultimately, the funds will be taxed upon the death of the corporation’s owner.
Life insurance on the corporation’s owner (this can sometimes be expanded to others) can be purchased by the corporation. One benefit is that the funds shifted to the life insurance policy are no longer subject to tax. But the biggest benefit is that a sizable percentage, if not all of the ultimate insurance payout, will be able to come out of the corporation tax free.
In many cases, the after-tax benefit of this strategy will be of significant financial benefit whether the insured lives one, 10 or 30 more years. In the right situation, it simply becomes wise estate planning, because most of the time, returns in excess of 10 per cent per year are possible if it is set up properly.
Using taxable investment income more effectively
This often applies to anyone with meaningful assets invested in taxable accounts, either personal non-registered accounts or corporate accounts.
As most of us know, in general, a dollar of income earned in a tax-sheltered account such as an RRSP, RRIF or tax-free savings account (TFSA) will not result in any tax owing, while that dollar of income in a taxable account is taxable. Of course, whether the dollar of income is interest income, Canadian dividends, capital gains or a return of capital determines how it is taxed.
The tax opportunity here is that some people hold tax-inefficient investments in taxable accounts and hold some tax-efficient investments in accounts that are tax sheltered.
For example, if you hold a bond paying six per cent in a taxable account, while at the same time you hold Alphabet Inc. shares (that don’t pay a dividend) in your RRIF account, you could lower your tax bill while not changing your investment holdings. You would simply sell both investments, then buy the Alphabet shares in your taxable account and buy the bond in your RRIF.
This will lower your taxable income because the interest income is now tax sheltered. The Google shares might create tax if you sell them for a capital gain, but it will be taxed at half the amount. If you end up selling the Alphabet shares at a loss, you can use the capital loss against other capital gains.
From a tax-efficiency standpoint, stocks that don’t pay income, stocks that pay Canadian dividends (U.S. dividends are treated the same as interest income) and real estate investment trusts (REITs) that pay much of their distribution as a return of capital are examples of ways to relook at your taxable investments (including inside corporations) to find ways to lower taxes.
Giving to charity more tax efficiently
This primarily applies to those who may give $10,000 or more to a charity, but, at its base level, giving a dollar to charity can generally provide a tax credit of between 40 and 50 cents depending on the province. This is a very good option and is appropriate for most smaller gifts.
Some people will use flow-through shares (as mentioned above) to improve the efficiency of charitable giving. The reason is that on top of the other flow-through benefits, a gift to charity will eliminate the capital gains tax on the shares, because donated shares don’t require you to pay this tax.
Other ways to gift more efficiently are to donate stock that has the highest percentage capital gain in your taxable portfolio, and to make gifts through a life-insurance policy, making the charity the owner while your annual insurance premiums are considered a charitable gift. This can be a powerful option.
The key is that if you are considering a larger charitable gift, either now or in your will, there are likely more tax-efficient ways to do this than simply through cash.
There are always aggressive tax strategies out there that may not end up being in your interest, but the ideas above can be powerful, yet straightforward ways for you to make some dent in your large tax bill.
Reproduced from Financial Post, January 18, 2023 .