Back in early February, before we all went into lock-down due to
Covid, I wrote about implementing a refreeze in a down economy. Who
knew back then that the economy would continue to drop like it did.
So it made me consider what other tax planning strategies to
consider, in addition to a refreeze, while our economy is still
down (if you haven’t read my February article, consider doing
so).
Triggering losses
I think it would be a safe bet to say that your investments
might have taken a hit in the last few months. So you may want to
consider which of your losers you might want to cut loose. By
triggering the loss in 2020, you can carry it back three years to
offset against any capital gains in previous years, or you can
carry forward the capital loss indefinitely to offset against
future gains. Note: If you are lucky enough to have gains in 2020,
you have to first use the losses against current year gains.
NOTE: Beware of the superficial loss rules when
triggering a loss. If you’re selling on the market to take a
loss, and you buy back an identical investment within 30 days
before or after the sale, the loss will be denied. Although these
rules are designed to counter artificial losses, they could apply
inadvertently – for example if you sell, then change your mind and
buy in again, maybe after the stock has dropped further. The rules
will also apply if your spouse buys back in within the 30-day
period (or a controlled company), but not if a child or parent
reinvests. The rules apply not only to stocks, but to mutual funds
as well. But they only apply if you repurchase an identical asset.
So if you sell Bank A and buy Bank B, you’re OK.
Note 2: When assessing whether you’re in a
loss position, don’t forget that capital gains are calculated
in Canadian dollars – so currency fluctuations can be a key
consideration. If the Canadian dollar has appreciated against the
currency there will tend to be losses.
Crystallizing gains
On the flip side, instead of triggering losses, you may want to
also look at triggering a capital gain. There has been much
speculation about whether the CRA will increase the capital gains
inclusion rate (currently at 50 per cent) in the 2020 Federal
Budget. Before Covid, the concern was due to the political climate
(i.e. the Liberals had a minority government and the NDPs had
campaigned on increasing taxes). The 2020 Budget was delayed with
the onset of Covid; and now the speculation is that perhaps the
government might increase the capital gains inclusion rate as a way
to raise money to fund the various government relief measures
released as a result of Covid. So if you anticipate a liquidity
event in 2020, you may want to consider crystallizing your capital
gain prior to the release of the 2020 Federal Budget, just in case.
And if you are not sure if there will be a liquidity event or not,
you can consider a strategy that would put the pieces in place to
trigger a gain, but still defer that decision until after the
Budget is released (you should reach out to your tax advisor to
discuss possible strategies). As to when the 2020 Federal Budget is
going to be released, your guess is as good as mine. So you should
have these discussions with your tax advisor sooner than later.
Capital Dividend Clean UP
If you hold your investments in a corporation, and are thinking
of triggering losses as discussed above, then the first thing to do
is to first check your corporation’s capital dividend account
(CDA) balance. What is a CDA? Well, as you know, only 50 per cent
of a capital gain is subject to tax. So when your corporation
realizes a capital gain, it only pays tax on 50 per cent of the
gain. The other 50% “tax-free” portion of the capital
gain is added to the corporation’s CDA. A tax-free capital
dividend can then be paid out of the corporation to you, the
shareholder (as long as you are a Canadian resident). However, if
the corporation realizes a capital loss as part of a loss selling
strategy, those losses will grind down the CDA balance and you will
lose the ability to take money out tax-free. So it is very
important to make sure you clear out your CDA by declaring a
taxfree capital dividend to you before you trigger any losses.
And if you don’t have any cash to pay the capital dividend,
the corporation can satisfy the capital dividend with a demand
promissory note so you can always pull that amount out tax-free in
the future.
Income Splitting opportunities
The Tax Act is full of various rules to prevent you from trying
to sprinkle income to lowtax family members (known as income
splitting). The “attribution rules” for example, would
apply where you transfer property or funds to your spouse
(including common law spouse) minor children, minor grandchildren
or minor nieces/nephews (“Family Members”), unless you
fall under certain exceptions. But in down economies, these
exceptions to the attribution rules generally get spotlighted.
One of these exceptions is the prescribed rate loan strategy. As
I have discussed in previous articles, you can avoid the
attribution rules if you, the higher income family member, loan
funds to the low-income Family Members, provided that they pay you
interest at the “prescribed rate” in effect at the time
the loan is made. Moreover, the interest on this loan has to be
paid by no later than January 30 each year. If you miss even one
January 30 deadline, the attribution rules will apply forevermore.
The prescribed rate has been at 2 per cent for the last little
while, but it is going down to 1% on July 1st, 2020 – so the
opportunity to income split through a prescribed loan will become a
lot more attractive.
If you don’t have cash to loan to your Family Member,
consider doing a loan “in kind”. For example, if you have
a securities portfolio in your name, transfer the portfolio to your
low-income spouse and have your spouse issue a demand promissory
note reflecting the prescribed interest rate for an amount equal to
the fair market value of the portfolio at the time of the transfer.
However, this transfer may be subject to capital gains tax by you,
the transferor, as the transfer would have to be made at the
portfolio’s fair market value. But if your portfolio has gone
down in value, then now is time to make that transfer.
NOTE: if you want to loan to any minor Family
Members, you should do so through a family trust, as minors cannot
legally borrow from you.
Defer RRSP Contributions
If your income / salary has gone down this year due to Covid,
you may want to consider deferring any RRSP contributions until
next year, especially if you expect to be in a lower tax bracket
for 2020. So hopefully, when you are back into the top bracket next
year, you can double up your RRSP contributions for 2021.
Originally Published by
The TaxLetter® June 2020
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
