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Registered Retirement Savings Plan (RRSP)

The 2006 contribution is limited to the lesser of 18% of 2005 earned income or $18,000 ($19,000 for 2007), minus the pension adjustment (PA) that applies to members of registered pension plans or deferred profit sharing plans. Some taxpayers may benefit from a pension adjustment reversal (PAR) in certain circumstances. Your 2005 Federal Notice of Assessment includes information on your 2006 RRSP contribution limit and unused contributions from prior years.

An individual who does not contribute his or her deduction limit for a given year can carry forward this unused deduction room indefinitely (actually, until the year the individual, or the individual’s spouse, reaches age 69).

Contributions do not have to be deducted in the year they are made, but can be carried forward and deducted in a future year.

A contribution in excess of the annual limit can be carried forward to be applied against the deduction room for any subsequent year. No penalty applies where an RRSP overcontribution (cumulative) is not more than $2,000, any excess being subject to a 1% per month tax.

Earned income for RRSP purposes is the total of all salaries (net of employment expenses), alimony, net research grants, income (loss) from a business, rental income (loss) and disability payments received under the Canada and Québec Pension Plans. Support (alimony and maintenance) payments made by the taxpayer will reduce earned income for RRSP purposes, if deductible for tax purposes.

The foreign property rule in respect of deferred income plans (including RRSPs), which limited the percentage of foreign property that a plan can hold, was eliminated in 2005.

All or part of an RRSP contribution may be made to a spousal plan (without affecting the contribution available to the spouse) if the spouse is under age 70. This can serve as an income splitting method upon the eventual withdrawal of the funds, provided the funds are left in the plan for a sufficient period of time.

RRSP contributions should, where possible, be made early in the year to benefit from the longer period that income is earned on a tax-sheltered basis within the RRSP.

Employees can ask their employer to pay a portion of their salary directly into an RRSP without deduction of income tax at source.

Contributions other than in cash are also permissible to self-administered RRSP plans. However, a non-cash contribution may result in a gain or loss. A capital gain would be taxable while a capital loss would be non-deductible.

A recipient of certain payments, most notably amounts received on leaving employment that are categorized as “retiring allowances”, can transfer all or a portion (based on specific limits) to their own RRSP on a tax deferred basis.

Individuals who have RRSP deduction room after age 69 will be able to contribute to a spousal RRSP up until the end of the year in which their spouse turns age 69.

If you turn 69 this year, you must mature (wind-up) your plans by December 31, 2006.

In order to avoid paying tax immediately upon the maturity of an RRSP, an annuity can be purchased and/or the RRSP can be transferred to a Registered Retirement Income Fund (RRIF).

If you turn age 69 this year and consequently cannot contribute to an RRSP in 2007 (assuming a spousal plan contribution is not available), you may contribute your 2007 - available RRSP deduction in December 2006 (before winding-up your RRSP) and pay a maximum penalty of $170 (1% of $17,000).

RRSP Education Withdrawals

Eligible individuals are able to make tax-free withdrawals from an RRSP to finance full-time training or education for themselves or their spouses. Withdrawals may not exceed $10,000 in a year and will be permitted for a period of up to four calendar years, provided that the total amount withdrawn does not exceed $20,000. Withdrawals under the plan will be repayable by the recipient in equal instalments over a period of 10 years, with the first payment due no later than 60 days after the fifth year following the first withdrawal.

The RRSP Home Buyers’ Plan

Subject to certain conditions, an individual who is a first-time home buyer can borrow up to $20,000 in a single year from his or her RRSP, repayable over a 15 year period. If you intend using the Plan towards year-end, consider deferring your withdrawal until after December 31. This will extend by one year the time period for repaying the amounts withdrawn.

Individual Pension Plan (IPP)

An IPP is an option for owners of incorporated businesses who wish to boost the amount of their retirement savings. Contributions are made by reference to the owner’s salary and the pension benefit desired, and can significantly exceed RRSP contribution limits, including a potentially large past-service contribution (and deduction) by the corporate employer.

Registered Education Savings Plan (RESP)

Under an RESP, contributions are made to a plan intended to pay for the post-secondary education of designated beneficiaries, usually the taxpayer’s children or grandchildren. Although contributions are not tax-deductible, income earned in the plan is not taxable until distributed, at which time it is taxed in the hands of the beneficiary. Annual contributions are limited to $4,000 per beneficiary to a lifetime total of $42,000. Contributions for 2006 must be made by December 31.

The Federal government will provide a grant (CESG) generally equal to 20% of the first $2,000 of annual contributions made to RESPs for each child up to age 18. A social insurance number must be provided for each child. The CESG will be payable on contributions made in the year to a maximum of $400 per child per year ($500 in certain limited circumstances).

Capital Gains Exemption

The capital gains exemption continues to be available to individuals who have not fully utilized it, but only in relation to gains realized on qualified small business corporation shares (or a family farm or fishing property).

Notwithstanding the income attribution rules, it may be advantageous to transfer a certain portion of qualifying growth assets to children to enable future capital gains to be exempt from taxation by utilizing the child’s capital gain exemption.

Consideration should be given to crystallizing a gain that qualifies for the exemption. Because of Alternative Minimum Tax (AMT), however, a crystallization may be more beneficial if spread over two years.

Be aware of the possible disadvantage of selling investments eligible for the $500,000 capital gains exemption and investments with losses in the same year. Capital losses realized in the year must be offset against capital gains of that year including “exempt” gains, thus leaving a smaller amount available to claim the exemption against.

Capital Gains and Losses

Capital losses realized in 2006 (net of any capital gains realized) can be carried back up to three years and carried forward indefinitely to offset capital gains reported in other years.

Capital losses will not be recognized at the time of disposition where, during the period that begins 30 days before and ends 30 days after the disposition of the property, the taxpayer or a person affiliated with the taxpayer acquires an identical property (a “superficial loss”). However, this rule can be used advantageously to transfer a capital loss to a spouse who has capital gains.

Corporations should consider paying a dividend out of the Capital Dividend Account (essentially the tax-free portion of net capital gains) prior to the realization of capital losses.

We encourage our clients to contact us before implementing any of the strategies described above, as the specific facts in a particular situation may indicate an alternate strategy. Remember that taxation concerns are only one aspect of a complete investment plan. Before realizing losses attention should be given primarily to the quality of the investments involved and their place in one’s investment plan.

Capital Gains Rollovers for Small Business Investors

To improve access to capital for small businesses with high growth potential, there exists a tax measure that, subject to certain conditions, permits individuals to defer capital gains on eligible small business investments to the extent that the proceeds are reinvested in another eligible small business.

Income Splitting

Investment income earned by an individual who is related to a lender who has made a low or non-interest bearing loan to them will be attributed to the lender. This will not apply where the loan is to a related person other than a spouse or minor child if it can be shown that none of the “main” reasons for the loan was to reduce or avoid tax. Nor will it apply where the loan is to a spouse or minor child if interest is charged at the prescribed rate in effect at the time the loan is made (the prescribed rate for the fourth quarter of 2006 is 5%), but when utilising this exception interest must be paid no later than 30 days after the end of the year to avoid attribution of income.

Since the attribution rules are extremely complex, caution is advised when contemplating a transfer of property or a loan to a spouse or a child (including transfers indirectly through a corporation in which they are shareholders).

Some basic planning ideas would include:

• gifting growth assets to a minor child, as the resulting capital gain is not attributed to the donor;
  
  
• gifting property to a child who is not a minor;
  
  
• segregating and re-investing “attributed” income of a spouse or minor child;
  
  
• segregating and investing child assistance and child tax benefit payments;
  
  
• using the higher-earner’s income to pay all family expenses and segregating and investing the lower-earner’s income;
  
  
• using a trust for the benefit of family members to hold shares of a closely-held corporation. However, there are restrictions in regard to income-splitting with minor children.
  

Spouses can choose to share their QPP and CPP retirement pensions.

Income splitting may be achieved by having your spouse be your business partner or by having a business owner pay reasonable salaries to his or her spouse or children.

Personal Income Tax Instalments

Individuals who are required to make quarterly instalments should review the amounts paid, to avoid or reduce the non-deductible interest charged (which can be onerous) on late or deficient instalments. Individuals are required to remit their Federal and Québec instalment payments on or before March 15, June 15, September 15 and December 15.

If the tax liability for 2006 will be less than originally estimated, the December remittance can be reduced accordingly.

Canada Revenue Agency and Revenue Québec will continue to notify individuals required to remit instalments of the amount of each instalment determined on the basis of tax information from prior years. Payments made in accordance with these notifications will always avoid interest charges.

Tax Assisted Investments

When considering tax assisted investments, it should be noted that most are speculative in nature. While they may result in significant tax savings, there remains a cost to the investor.

The decision to invest should be based on the quality of the investments as well as the favourable tax treatment they receive.

Film Investments

The purchase of an ownership interest in certified Canadian films continues as a tax deferral vehicle by allowing the investor certain tax credits.

Investment in the Petroleum, Gas and Resource Industries

These investments, whether made directly, through a partnership or by the purchase of shares, allow the investor a deduction from income of varying amounts depending on whether the investment is in oil and gas or mining.

The income tax rules and financial implications relating to such investments are extremely complex and should be reviewed on an individual basis.

SME Growth Stock Plan

Québec Stock Savings Plan (QSSP) investments are no longer possible. Tax assisted investments in Québec corporations can now be made through the SME Growth Stock Plan. This new plan will itself end on December 31, 2009. A single deduction rate, 100% of the adjusted cost of eligible shares, will apply. The annual deduction cap of 10% of the individual’s income for a year that applied under the former QSSP will apply under the new plan.

Pension Income Credit

An individual may be entitled to a Federal tax credit on up to $2,000 of pension income (Ontario $1,158; Québec $1,000). OAS and QPP (CPP) pensions are not eligible for the pension income credit. The Québec credit is reduced when “family income” exceeds $28,710.

If there is not sufficient pension income to qualify for the full amount of the credit, additional qualifying income can be created by commencing to receive pension income in the form of a life annuity and, if age 65 or older, also by converting all or part of your RRSP plan into an annuity, or by simply purchasing an ordinary (unregistered) life annuity contract with other funds.

Donations

If planning to make any donations to a public charity, consider contributing marketable securities that have inherent gains, as the income-inclusion rate of the resulting capital gain is zero for donations made after May 1, 2006. The donation credit is based on the market value of the securities.

Alternative Minimum Tax

The AMT imposes a minimum tax on certain individual taxpayers and could adversely affect those high-income individuals who have significant deductions arising from investments in tax shelters. Certain shelters such as flow-through shares of mining companies, etc. as well as large capital gains and eligible dividend income may subject the individual to the AMT in 2006.

Taxpayers who have paid the AMT in the past may have an opportunity in 2006 (and following years) to recover part or all of the AMT previously paid.

Changes made to the Québec AMT system in 2003 result in individuals (including trusts) being far less likely to be subject to AMT. The changes also make it easier to recover AMT paid in prior years.

Salary/Dividend Planning

Many factors must be considered in determining the most beneficial combination of remunerating the owner/manager of a closely-held corporation. As with other planning, each case must be examined separately and no one “rule of thumb” can apply to all situations.

The proposed changes, starting in 2006, in the taxation of dividend income (see discussion below under 2006 Budgets) will have to be taken into account in this determination.

Some factors to be considered are:

• The tax rate of the corporation
  
  
• The tax rate of the individual
  
  
• The need for salary income by the individual to qualify for RRSP and CPP/QPP contributions or to benefit from childcare expenses
  
  
• Wage levies applicable to salaries, such as the Ontario Employer Health Tax and Québec’s health services fund and 1% training “tax”
  
  
• Québec restrictions on the deductibility of investment expenses by individuals
  
  
• Whether eligible dividends can be paid to shareholders
  

Some planning techniques include:

Remuneration that is accrued and expensed by a corporation must be paid to the employee within 179 days of the corporation’s year-end. Where that year-end falls in the latter half of the calendar year (actually, after July 6), the corporation can cause the owner/manager’s remuneration to fall into either the current or subsequent calendar year.

The payment of dividends can be used to reduce or eliminate the owner/manager’s CNIL, thus maximizing the amount of capital gains exemption that may be available to the taxpayer

Timing of Acquisition of Assets

Accelerate the acquisition of depreciable property used in carrying on a business otherwise planned for the beginning of the next year. This will allow additional depreciation to be available to be claimed in the current year. The “available-for-use rules” should be considered (generally requiring the depreciable property to be used in operations for the depreciation deduction to be allowed).

Conversely, consider delaying until the subsequent year the acquisition of depreciable property in a class that would otherwise have a terminal loss in the current year.

Shareholder Loans

If contemplating a loan from a corporation to a shareholder, the potential taxability should be evaluated

Corporation Tax on Capital

A tax on capital may be imposed on certain corporations in certain provincial jurisdictions including Ontario and Québec. The Federal version, Part I.3 Tax, was eliminated effective 2006. This tax may be reduced for a corporation that has cash on hand by using it before the end of its fiscal year to (a) reimburse shareholder loans, (b) reduce existing borrowing, or (c) acquire eligible investments.

In regard to Québec tax on capital, eligible investments must also meet the following criteria:

• Investments in bonds, commercial paper and bankers’ acceptances of other corporations have to be held for a continuous period of at least 120 days including the date of the taxation year end;
  
  
• The 120 day holding period has been extended to cover bonds of partnerships, as well as shares of banks and their related corporations;
  
  
• Shares of and loans to other corporations are generally not restricted.
  

Both Federal and Québec Small Business Deduction amounts are reduced when the aggregate taxable capitals of associated corporations for the preceding year exceed $10 million. This means that it will still be necessary for corporations in associated groups with taxable capital approaching or in excess of $10 million to calculate taxable capital for Federal purposes, and it will continue to be advantageous in these circumstances to reduce taxable capital whenever possible.

Employee Stock Options

Employees may be able to defer the income inclusion of benefits that result from exercising eligible employee stock options for publicly listed shares until the disposition of the shares, subject to an annual $100,000 limit. Employees disposing of such shares will be eligible to claim the stock option deduction in the year the benefit is included in income

Gifts and Awards To Employees

CRA and Revenue Québec have liberalized their approach towards employee gifts and awards.

Employers can now give their employees, on a tax-free basis, two non-cash gifts and two non-cash awards each year. The total cost of the gifts and the total cost of the awards must not exceed $500. Certain conditions apply.

2006 Budgets

Certain measures announced in the 2006 Federal and provincial budgets may require your attention before the end of the year.

Universal Child Care Benefit

All families should now be receiving $100 per month for each child under the age of six years. Contact your BGK advisor if you are not currently receiving this amount for all eligible children.

Tax Credit for Public Transit Passes

In order to claim this Federal credit for themselves and their families (including minor children), taxpayers should retain their monthly (or longer period) transit passes and receipts.

Refundable Tax Credit for Home-Support Services for Seniors

This program has been available since January 2000 to residents of Québec over 70 years of age and grants a tax credit to help pay for eligible home-support services costs such as cleaning, gardening, minor household maintenance and assistance with shopping, dressing and personal hygiene. A portion of rent and condo fees may also be covered. See Revenue Québec publication IN-102 for more details.

The administration of this credit will undergo major changes starting January 1, 2007. In future the credit will be claimed when filing the Québec income tax return. Payments through Desjardins/SEP will cease but it will still be possible to obtain advance payments through Revenue Québec. Where salary paid to your employee is an eligible expense it will now be necessary to register as an employer and deduct and remit payroll deductions at source. The maximum credit will increase from $2,760 (23% of $12,000) to $3,750 (25% of $15,000). The proposed deductible of the first $300 of eligible expenses announced in the budget has since been cancelled.

Taxation of Dividends

Major changes to the taxation of dividend income received by individuals were announced in November 2005 and confirmed in the 2006 Federal budget, effective for dividends paid after 2005. Many provincial governments have announced the extent to which they will mirror (or otherwise) the proposals. Draft legislation was issued in June by the Department of Finance and reissued in October with several changes. It is, of course, possible that further changes will be made before Royal Assent.

Based on the draft legislation issued on October 16 there will henceforth be two types of taxable dividends that can be paid by taxable Canadian corporations – eligible and other. It is likely that most dividends paid by public corporations will be eligible dividends, as will dividends from private corporations out of active income on which a Small Business Deduction was not claimed. The taxation of taxable dividends other than eligible dividends will continue with the current treatment for Federal purposes; however Québec actually increased the top marginal rate for other dividends from 32.81% to 36.35% for dividends paid after March 23, 2006.

Corporations will have to advise their shareholders when an eligible dividend is paid.

The top marginal rate on eligible dividends for residents of Ontario will vary from 25.09% in 2006 (down from 31.34% on taxable dividends in 2005) to 22.38% in 2010. In Québec the top marginal rate on eligible dividends will be 29.69% (32.81% in 2005).

Although the tax payable on eligible dividends will generally be lower than in prior years, certain problems are evident:

• Calculating the amount available to pay eligible dividends is complex, and there are significant penalties where an excess amount is paid.
  
  
• Optimal salary/dividend planning is now made significantly more difficult.
  
  
• Benefits that are reduced based on net income will be affected by the higher gross-up (OAS clawback, child tax benefit, medical expense credit, etc.).
  
  
• Alternative Minimum Tax will become more likely to be an issue, particularly where eligible dividends form a significant part of an individual’s income.
  
  
• Corporations, mutual funds and brokers will have to modify their systems in order to be able to report correctly to shareholders. It seems likely that many 2006 T5s and T3s will be issued later than usual.
  
  
• Ontario has decided to phase in their modifications over a five-year period, ending in 2010.
  
  
• Québec is implementing the concept of eligible dividends effective March 24, 2006. Thus for 2006 eligible dividends may be different for Federal and Québec purposes.
  
  
  

Other Matters to Consider

Interest Deductibility

Whenever possible, ensure that debt is structured so that the interest expense is deductible. When repaying an existing debt, pay off the debt that has non-deductible interest before debt with deductible interest.

Québec restricts the deductibility of investment expenses including interest and advisor fees. Investment expenses are only deductible by individuals to the extent of investment income, including taxable dividends and taxable capital gains. Disallowed investment expenses can be carried back up to three years or forward indefinitely. The Federal government is also considering certain restrictions.

Contact your BGK advisor to discuss ways to minimize the impact of these measures.

Wills and Mandates

Wills should be reviewed and updated on a periodic basis, taking into consideration changes in family circumstances (e.g., children emigrating), financial position and legislation.

U.S. Citizens in Canada

A U.S. citizen resident in Canada must file Canadian and U.S. income tax returns, reporting worldwide income. These tax returns should usually be prepared by a competent professional advisor, due to the complex interplay of foreign tax credits.

U.S. citizens and residents with Canadian RRSPs or RRIFs are able to elect to defer recognition of the income arising in the plans until it is received. Recent IRS announcements have significantly increased the U.S. reporting requirements for such plans.

Logbook for an automobile - Québec

For 2005 and onward, an employee who benefits from an automobile made available by the employer will have to supply the employer with a copy of the detailed logbook he or she maintains with respect to the automobile so as to allow the employer to accurately determine the employee’s taxable benefits. The copy of the logbook has to be provided within ten days from the end of the year or from the end of the period in which the automobile was made available to the employee. Failure to provide the logbook to the employer will result in a penalty to the employee of $200.

Manpower Training

Québec employers with a payroll in excess of $1,000,000 are required to spend the equivalent of 1% of their payroll on job training.

Employers subject to this 1% requirement that do not expend that amount will be required to contribute the shortfall as a “tax”. Consequently, employers should evaluate their manpower training programs and facilities in order to determine how they can meet the criteria that will enable them to reduce or eliminate the tax. Your BGK advisor will be pleased to assist you.

Eligible training expenses incurred in a year in excess of the 1% required can be used in the following year.

Québec Real Estate Labour Costs

When work is performed on real estate located in Québec that is used in a business or to earn income, the identity of the persons performing the work and the amounts paid must be reported to Revenue Québec each year. For instance, individuals earning rental income must file form TP-1086.R.23.12 each year reporting the names, addresses, Social Insurance Number or Québec Sales Tax identification number, and amounts paid for all persons who performed work on the property – from the contractor who replaced the roof to the gardener. Payments to employees do not have to be reported, but payments to a contractor by a company for work done on a property that it leases are subject to these rules. You may be liable to penalties of $200 for each unreported payment recipient.

GST/HST Registry

The GST/HST Registry was recently introduced by CRA and allows you to validate the GST/HST number of a business, which helps to ensure that claims submitted for input tax credits only include GST/HST charged by suppliers who are registered for GST/HST. Québec has a similar service available to validate Québec Sales Tax numbers. The services are available through the CRA and Revenu Québec websites, links to both of which can be found on our website www.bgk.ca. Verifying supplier registration numbers is only one of the steps required to ensure that input tax credits/refunds are being validly claimed by your business.

Construction Industry Reporting

Businesses whose principal activity is construction must keep a record of the name, address and Business Number or Social Insurance Number of their subcontractors, and the amounts they were paid in the year. This information must be reported to CRA annually.

Mutual Funds

Many funds make distributions at the end of the year. If you are thinking of purchasing fund units at this time, you may be receiving an unexpected income inclusion without the benefit of the growth in value of the units through the year.

Foreign Withholding Taxes

Foreign withholding taxes are only creditable at the rate allowed for in the particular treaty. Ensure that, for example, withholding taxes on U.S. dividend income do not exceed 15%.

Any excess amounts withheld may have to be recovered from the source country.

Government Pensions

For persons who have turned or are about to turn 65, assure that OASP and QPP/CPP retirement applications are prepared.

Reduced QPP/CPP retirement benefits are available to persons between ages 60 to 65 and retired.

Enhanced QPP/CPP benefits are available if the application is delayed until after age 65 (up to 70).

Old age spousal or widow(er)’s allowances may be available, based on an income test, to a person aged 60 to 64:

• whose spouse is a GIS (OASP Supplement) recipient, or
  
  
• who is a widow(er)
  
  

Québec Prescription Drug Insurance Plan

When Québec residents turn 65 they are automatically enrolled in the Québec Prescription Drug Insurance Plan and are subject to the $529.50 (for 2006) annual maximum premium. If you are in this situation and are also a member of a group insurance plan that fully covers prescriptions, you may request to the Régie de l’assurance maladie du Québec that you not be covered by the Québec plan. If you opt out of the Québec plan, ensure that you use the group plan only, and for every prescription purchased during the year. However, the associated costs and benefits must be evaluated before opting out.

All individuals under 65 who are eligible for coverage under a group insurance plan (e.g. members of many professional bodies) must purchase coverage under the group plan for themselves (and their spouse and children) and are ineligible for the Québec plan.

Snowbirds

Canadians who spend on average more than 120 days a year in the United States run the risk of being considered a U.S. resident for U.S. tax purposes. If you are caught under the specific rules, but have spent less than 183 days in the U.S. in the current year, the “Closer Connection Exemption” may apply. The exemption is claimed by filing IRS form 8840 on a timely basis (generally June 15 of the following year). Please contact your BGK advisor for more details.

Ontario Health Premium

The Ontario Health Premium is now fully phased in with premiums ranging from $0 where an individual’s taxable income is less than $20,000 to $900 where taxable income exceeds $200,600.

Did You Know...?

This and other issues of Current Developments are available on our website at www.bgk.ca.

The matters described herein, as well as other techniques used in tax planning, should be subject to ongoing review and analysis and, frequently, some decisions may more appropriately be implemented earlier, rather than later, in the year.

DATES TO REMEMBER