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Tax smarts pay off for investors

by Wayne Cheveldayoff, 2005-03-31

A little tax planning can help investors save on income taxes, and any saving helps build wealth.

The best-known strategies involve registered plans such as RRSPs, RESPs and RRIFs, which are used to defer income taxes on investment gains until the funds are withdrawn.

For investing outside of registered plans, there are several ways to lighten or postpone the tax load.

A simple tactic, yet one that is not used as much as it should be, allows parents to save income taxes when investing on behalf of their children. Parents can set up a separate savings or investment account under a child’s name to deposit Child Tax Benefit cheques. As long as the child’s income is under the basic personal amount (around $8,000), the money will earn interest or other investment income tax-free.

Another way to save is for parents to establish in-trust accounts for their children at discount or full-service brokerages. While interest and dividends earned in such accounts are attributed back to the contributing parent who must pay income tax on them, any capital gain is taxed in the hands of the child.

Thus, in the absence of other income, a child could have taxable capital gains of around $8,000 a year without paying tax.

When parents use such accounts in conjunction with RESPs to save for a child’s education, it can be advantageous to invest in bonds or GICs in the RESP (since withdrawals down the road will be taxed in the hands of the child) while reserving the in-trust account for securities with capital gain (or return of capital) potential.

Of course, an important part of any investment strategy is recognizing the range of tax rates that apply to different investment income.

In Ontario, if you are taxed at the top marginal rate of 46 per cent, you would pay this rate on interest and business income (from income trusts). Dividends would be taxed more favourably at about 34 per cent and capital gains and return of capital at 23 per cent.

It makes loads of sense, therefore, in choosing income trusts to seek out trusts that pay a high proportion of their cash distributions as dividends or return of capital. The return of capital is not taxed immediately. Rather, it causes a reduction in the adjusted cost base of the investment and will be taxed as a capital gain when the investment is sold.

Investing in resource tax shelters is another route to tax-effective investing. For instance, putting $10,000 in such a tax shelter will produce a $10,000 deduction against other income in the same year. When the investment is eventually sold, the entire amount received will be taxed as a capital gain.

If you have capital gains, you can trigger capital losses on other investments to offset the gains. The losses can be applied back three years (so you can save on taxes you have already paid) or carried forward indefinitely.

On the tax return, several items under “carrying charges” can be used as deductions to reduce income taxes payable. These include the cost of safety deposit boxes and fees paid to investment counsel (although not those paid on mutual funds).

Carrying charges also include interest on money borrowed to invest. The Canada Revenue Agency is contemplating changes to the interest-deductibility rules, so it is necessary for investors to consult a tax accountant before making a move.

But there are several things that can be done. For example, you may be able to borrow at 6 per cent and invest in income trusts that pay distributions at 8 or 10 per cent annually, with the opportunity for capital gains if you choose trusts with good growth potential. (There is also the potential for capital losses, so such a strategy carries some risk.)

In fact, with a proper paper trail to satisfy a CRA auditor, you can make home mortgage payments tax deductible by selling non-registered investments, paying down the mortgage, and then arranging a new mortgage for the purpose of investing. The interest on the new mortgage should be tax-deductible. Again, it would be wise to consult a tax accountant to make sure it makes sense to do this, as there may be substantial capital gains taxes to pay when the original non-registered investments are sold.

Wayne Cheveldayoff is a former investment advisor and professional financial planner. He is currently specializing in financial communications and investor relations at Wertheim + Co. in Toronto. His columns are archived at and he can be contacted at

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©2005 Wayne Cheveldayoff