The March 21, 2013 federal budget introduced specific tax measures aimed at individuals and small businesses. While Budget 2013 did not make any changes to tax rates, some of the changes will affect most Canadians to some degree. Here is a summary of the key elements that may affect your financial plan.
New first-time charitable donor Super tax credit
For those of you who have been wanting to donate, an extra 25% tax credit has been announced. The new First-Time Donor’s Super Credit is designed to encourage first-time charitable donors through an enhanced tax incentive. The standard tax credit for a donation is 15 per cent of the first $200 and 29 per cent for amounts beyond that level. The super credit, which the government describes as being temporary, would add an extra 25-per-cent tax credit for cash donations up to $1,000.
Bottom line, the new credit would give first-time charitable donors a 40-per-cent credit for the first $200 or less and a 54-per-cent credit for amounts between $200 and $1,000. It pays to give!
New enhanced adoption tax credit
There are some other small measures for families, including an enhanced adoption tax credit that can be used to help offset costs incurred before parents are matched with a child. The new Adoption Expense Tax Credit (AETC) is a 15% non-refundable tax credit up to $11,669 per child.
The cost of renting a safety deposit box has traditionally been a deductible expense as a carrying cost. The budget proposes that the cost of renting a safety deposit box will no longer be deductible, beginning in 2013, justifying this change by saying that “taxpayers using safety deposit boxes are increasingly likely to be using the boxes for personal purposes (e.g., to safeguard valuables), rather than for an income-earning purpose.”
Converting Income to Capital Gains – Closing out the use of income producing “Tax Class” funds
This will affect many of you who currently have income producing corporate class a.k.a. Tax class funds. The budget proposes new rules that would effectively eliminate the ability for investors to convert fully taxable ordinary income into tax-preferred capital gains, taxable at only 50% of your marginal tax rate. The changes proposed will affect mutual funds that invest in a portfolio of bonds to earn interest income and then use forward derivative contracts to convert highly taxable distributions into distributions of capital gains. The net result is that in respect of forward agreements entered into on or after March 21, 2013, these funds will no longer be able to provide this tax advantage. The use of corporate funds will still be useful to avoid tax on the switches made between funds of the same class but will eliminate the tax advantage of the income generated. We will keep you up to date on the developments of this proposed change as we find out.
Labour-Sponsored Venture Capital Corporations Tax Credit
The budget announced that it will be phasing out its federal tax credit for investments in labour-sponsored venture capital corporations (LSVCC). While the credit will remain at 15% for 2013 and 2014, it will drop to 10% for 2015 and 5% for 2016. It will be completely eliminated for 2017 and subsequent years. In addition, the government will immediately cease registering any new federal LSVCCs.
Revised Form T1135
If you own foreign property costing more in total than $100,000 at any time during the year, you must file a “Foreign Income Verification Statement” (Form T1135). Foreign property includes foreign bank accounts, foreign non-personal real estate, and foreign stocks (but not Canadian mutual funds or segregated funds with foreign holdings) held in non-registered Canadian brokerage accounts.
Currently, Form T1135 only requires general information as to where the foreign property is located and what income is generated from that property. The CRA will be revising this Form and require taxpayers to provide more detailed information regarding each foreign investment, including: the name of the specific foreign institution or other entity holding funds outside of Canada, the specific country to which the property relates and the foreign income generated from the property.
Beginning with the 2013 tax year, the CRA will remind taxpayers, on their Notices of Assessment, of their obligation to file Form T1135 if they have checked the “Yes” box on page one of their tax returns, indicating that they own foreign property with a total cost of more than $100,000. The CRA is also developing the ability to file the T1135 form electronically.
-SMALL BUSINESS CORPORATE TAX CHANGES-
Lifetime Capital Gains Exemption
The budget proposes to increase the Lifetime Capital Gains Exemption (LCGE) on the sale of a small business by $50,000 from $750,000 to $800,000, starting in 2014. In addition, the LCGE will be indexed to inflation for taxation years after 2014 and the increase in limits will also be available to those who have previously used their full $750,000 exemption. This is a welcome news to small business owners.
Dividend Tax Credit for non-eligible dividends
The most significant tax measure in the budget could be an adjustment in the dividend tax credit as it affects non-eligible dividends, or those paid by small businesses (not publicly-traded blue chip dividend stocks). The change will business owners who pay themselves dividend income instead of salaries and will result in more taxes being paid on these non-eligible dividends paid after 2013.
The government has realized the intention of the gross-up tax credit system is to integrate corporate taxation and personal taxation but it‘s gotten out of sync over the years so that someone who is running a small business is actually ending up with a larger tax benefit by having the dividend come out of their small business corporation.
To fix this, the budget proposes to adjust the gross-up and dividend tax credit for dividends paid after 2013, from 25% to 18%. The net result will be higher taxes on non-eligible dividends, starting next year.
Estate Planning related changes
Testamentary trusts are trusts created upon death, generally in your will. These trusts calculate tax using the graduated tax rates applicable to individuals as opposed to other trusts, such as inter-vivos trusts, which pay federal tax at the highest marginal rate of 29 per cent. The taxation of testamentary trusts at graduated rates allows the beneficiaries of those trusts to effectively access more than one set of graduated rates and is often recommended as a great estate planning strategy.
The government announced that it is “concerned with potential growth in the tax-motivated use of testamentary trusts and the associated impact on the tax base” and as such, intends to launch a consultation on possible changes to the tax law to eliminate the tax benefits that arise from taxing testamentary trusts at graduated rates. We will be sure to keep you up-to-date on that front as well.
Several tax loopholes have also been closed such as the 10/8 insurance policies and loans arrangements, Leverage Insured annuities, strategies we never used here at You First.