Closing the loop on HNW clients

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Round two of Budget 2011 continues to tighten the vise on high-net-worth clients.

In a repeat budget, at least as it concerns HNW clients, the government reaffirmed commitments to close tax-planning loopholes. The government believes it will save $1-billion by 2013/14 by cracking down on perceived tax avoidance.

“The government is putting forth [initiatives] to ensure the tax base is not eroded by looking at measures that have not made Canadians equal across the board,” says Mike George, director of the wealth and estate planning team at Richardson GMP. “Most Canadians like the idea that the tax base is maintained and that there are no special privileges.”

This may be true for the average Canadian, but for HNW clients, proposals to close these loopholes mean fewer tax planning opportunities.

“The definition of what is considered a loophole and abusive is getting greater and greater, to the point that transactions that are being done for legitimate non-tax reasons are being caught,” says John Campbell, tax group leader and associate partner at Hilborn Ellis Grant LLP in Toronto.

And not just taxpayers suffer. One disappointing development, says George, is the proposed elimination of the ability for investors to double dip when donating flow-through shares to charity.

Previously, investors would receive a resource exploration tax credit upon purchase of flow-through shares issued by oil and gas, mining, or renewable energy companies. These companies use the proceeds for exploration and flow the associated tax deductions through to investors, bringing the investors’ adjusted cost base to zero. Upon sale of these shares, the entire value would be taxed as a capital gain. When investors would donate the shares, they would receive a tax receipt for the entire value, but were not required to pay tax on the capital gains realized on the disposition. This meant that a $100,000 donation of flow-through shares could result in a cost to the shareholder of only $5,000.

The government has proposed to close this so-called loophole: taxpayers would only be exempt from the capital gains tax to the extent that their capital gain exceeds the amount paid for the shares.

George says this move will likely reduce the amount HNW clients will donate to charity.

“It’s a shame since it hits the charitable sector, which is already hurting for money,” he says. “Certainly a large component of our clients were able to direct a significant amount of funds to charity, so they’ll need to reevaluate that strategy altogether.”

Other issues that affect HNW clients include the proposed change to the ability of affluent parents to split income with low-income, minor children by not only restricting income splitting with a minor, but also capital gains splitting.

“We used to be able to attribute a capital gain to a minor child without any tax consequences, but now they will apply the kiddie tax on that transfer,” says Annie Boivin, manager of wealth and estate planning at Richardson GMP.

The budget also states in Annex 3 that the Aggressive Tax Proposals introduced in the March 2010 budget will be moving forward. These AT Proposals, as covered in the February 2011 issue of Advisor’s Edge Report, would essentially require any professional who receives fees for assisting clients with a tax plan that provides tax benefits to report such activities to the CRA. This also concerns Campbell.

“The [Aggressive Tax] Proposals are an example of anti-avoidance legislation that is so complex and difficult that [it has] taken 10 years to draft,” he says. “[The proposals] are difficult to comply with due to their complexity and are likely going to spend years in court trying to define their application.”

For Campbell, this is yet another sign of government overreaction.

“The reach of this budget is moving towards challenging real investment strategies and real business transactions as opposed to just closing down loopholes,” Campbell says. “Whenever government introduces legislation to prevent perceived abuses, many times they take a sledgehammer to a fly and introduce legislation that’s so complicated that it’s not effective, or it’s so restricted that it has unintended consequences on taxpayers and professionals.”

Retirement income

Another recycled restriction: the budget proposes annual minimum amounts be withdrawn from IPPs once a plan member reaches the age of 72. Also, contributions made to an IPP that relate to past years of employment will effectively be required to be funded first out of a plan member’s existing RRSP, or by reducing the individual’s accumulated RRSP contribution room before new deductible contributions in relation to past service may be made.

“That penalizes a person who was good at saving and investing in an RRSP,” says David Sung, president of Nicola Wealth Management. “The budget actually [benefits] people who are less responsible in their saving and investing choices. I’m going to be very curious as to how they’re going to implement these IPP changes.”

Tackling IPPs at all also seems wrongheaded to John Nicola, CEO of Nicola Wealth Management.

“The problem is not the IPP, the problem is the RRSP,” he says. “IPPs are a legitimate, proper way of drawing money out of registered capital without destroying the capital over your lifetime.”

Nicola explains the RRIF rules were designed for a time when interest rates were much higher. “They’re unrealistic. The withdrawal rate should never be 7.4%; it should be 5% at most,” he says. “They should address [that], but don’t want to do because [the government] makes a lot of money when people take more money out of their RRSPs and their RRIFs. Not only does [the government] get more money from taxes, but it increases the chance that somebody is going to have an OAS clawback.

“The whole RRSP required withdrawal is antiquated,” he continues. “People live longer and their retirement savings have to last longer. You cannot have rules that destroy their capital before they’ve ended their life expectancy.”

Now that the budget is all but law, advisors should be ready to change their advice accordingly.

“Investment advisors have to be careful – not every investment is eligible for an RRSP like it used to be,” says Boivin. “Before we could swap investments from a regular portfolio to an RRSP portfolio. We can’t do that now.”

Melissa Shin

Melissa is the editorial director of Advisor.ca and leads Newcom Media Inc.’s group of financial publications. She has been with the team since 2011 and been recognized by PMAC and CFA Society Toronto for her reporting. Reach her at mshin@newcom.ca. You may also call or text 416-847-8038 to provide a confidential tip.