Several provinces are cash-strapped, and are looking to collect more tax.

In Quebec, the Parti Québécois (PQ) finally back down on its plan to introduce two new individual income tax brackets and to increase the capital gains inclusion rate to 75% (from 50%) and to cut the dividend tax credit by half.

Read: Brace clients for the 2% wealth surtax (in Ontario)

As shown in the table, with the initial proposal, the Quebec combined top marginal tax rate for interest, rent and regular income would have spiked to as high as 55.22% (from 48.22%).

Moreover, the proposed changes regarding capital gains and dividends would have impacted all clients, not only the wealthy.

2012 Combined Top Marginal Tax Rates (“MTR”) for Individuals

(as initially
Alberta Ontario
Interest, Rent and Regular Income
  • $132,406 to $249,999
48.2 52.2 39 46.4
  • $250,000 and over
48.2 55.2 39 46.4 / 47.95 / 49.5
Eligible Dividends 32.8 50.7 19.3 31.7
Non-eligible Dividends 36.4 50.1 27.7 34.5
Capital Gains 24.1 35.4 19.5 24

Given most governments are under pressure to cut expenses or increase taxes, there are several considerations to address with clients as part of your year-end planning meeting, no matter where you’re located. If your client is a business owner, an incorporated professional or if he owns a rental property, discuss the following:

  1. Defer tax

    If your client earns more than $130,000 and has substantial savings every year, he should consider keeping these savings into a corporation rather than being taxed personally.

    Why? Because active business income up to $500,000 is taxed at only 19% in Quebec (between 11% and 15.5% in other provinces) as oppose to the top MTR of 48.2%. This strategy creates a tax deferral of 29.2%.

  2. Corporate-class mutual funds

    Investors have used corporate-class mutual funds with substantial non-registered assets when looking for higher after-tax returns on fixed-income investments. These solutions are promoted for their tax-efficient distributions in the form of capital gains and dividends, rather than interest income.

    Should the governments cut the dividend tax credit by half, a Quebec investor, for example, in the $130,000 to $249,999 tax bracket would be taxed at 52.2% on interest income versus 50.7% on eligible Canadian dividends. Therefore, it may no longer justify the higher fee charged by corporate-class mutual funds.

    Read: Why use corporate-class funds?

  3. Split income

    Business owners should take advantage of either discretionary shares or, even better, a discretionary trust to split income. At the discretion of the directors or trustees, a taxable dividend can be allocated and taxed in the hands of the beneficiaries—a spouse or an adult child. When the beneficiaries have no or low income, the dividend shouldn’t trigger any tax. At the very least, the tax impact should be significantly less than if taxed in your client’s hands.

  4. Live off your investment

    Investors have used solutions like T-Series mutual funds to receive money back as a return of capital and defer tax until a disposition occurs. The benefits of this option helps clients avoid the OAS clawback, or stay in a lower tax bracket.

    If your client is nearing retirement, he should consider living off his capital rather than from the income it generates, especially if he plans to retire in a lower tax jurisdiction in the medium or long term.

    Fortunately, for business owners, there is also the option to roll certain assets like a rental property to their corporation without triggering a disposition for tax purposes. This strategy will enable your client to cash out the tax cost of their property, on a tax-free basis, and defer until the corporation sells the property.

  5. Convert your salary into a capital gain or dividend

    If your client has non-registered investments or a rental property, he can also choose to sell rather than roll these assets to his corporation. It will trigger a disposition and create a capital gain. He will then be able to cash out, on a tax-free basis, up to the market value of the assets transferred rather than only up to his tax costs.

    Because tax-free withdrawals helps him postpone the payment of a salary or dividend, the end result is that taxes are paid at the capital gain rate rather than at the salary or dividend rate.

    A similar result can be accomplished by transferring a life insurance policy to your client’s corporation. If the cash value is lower or equal to the tax cost of the policy, there will be no gain triggered on the disposition and he will be able to withdraw up to the market value of the policy on a tax-free basis. Moreover, future premiums will be paid with money taxed at 19% (Quebec) rather than at48.2%.

  6. Interprovincial planning

    If the circumstances are justifiable, your client could set up a family trust outside his province of residence. The residence of a trust is determined by the residence of the trustees who exercise management and control over it. For example, if such trustees reside in Alberta, the investment income earned by the trust could be taxed in Alberta rather than Quebec. However, be wary of this option, as provinces have anti-avoidance rules that will block such planning when there is no purpose other than to obtain a tax benefit.