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Recently a client of mine went ballistic when I told her how much she owed Revenue Canada on April 30th, over and above what she had already paid in installments during the year. She paid quarterly installments to RevCan based on what she'd paid the previous year, and she earned the same amount this year. However, this year a lot of the investments she held outside her RRSP, produced investment income (capital gains & dividends) and she'd forgotten all about them. So after the reality of the Canadian taxation system had set in, she sat there in my office with tears welling up in her eyes and asked me, "is there any way that I can pay less taxes on my non-registered investments?" To which I replied, there sure is. I've been preaching to my clients, (including this lady) for years to set up family trusts if they have children under 18 years of age; and if they have children over 18, to set up personal investment holding companies. However like most middle class Canadians, my client being no different, they have an inherently Canadian attitude towards paying taxes, which leads them to believe that only rich people can use those things. I know this isn't true, but most middle class Canadians are hard to convince. Let's take a look at both:
Family Trusts - Example: Mr. & Mrs. J. Own 100% of the shares of the family business, XYZ Widgets Inc., which has annual net after tax earnings of $150,000. They have four kids under the age of 18. The J.'s get grandpa to settle (set up) a family trust with the four kids as the beneficiaries. The family trust then subscribes to shares in XYZ Widgets Inc. Every year XYZ Widgets pays dividends to the trust in the amount of $92,000 ($23,000 x 4). The trust then pays out ALL the money, on behalf of each child, throughout the year, and allocates the dividends in direct relation to the expenditures that the parents make on behalf of each child, (i.e. summer camps, golf memberships, hockey gear, bikes, class trips, etc.). As long as the trust allocates $23,000 to each child, there are no taxes to be paid on that $92,000. This dividend aspect of the family trust is going to change beginning Jan. 1, 2000. As of the 1999 federal budget, starting in 2000, any dividend received by the child through the trust, from a related small business corporation, will be taxed at the highest federal tax rate, 29%. This brings the above tax-free amount down from $23,000 to around $5,600 per child, which still isn't bad. However, if the dividend was paid into the trust from shares of an unrelated corporation that is listed on a prescribed Canadian stock exchange, i.e. BCE, Royal Bank, Seagrams, etc. Then the above rule doesn't apply. This brings me back to my client weeping in my office. Most of her open investments are in high dividend yielding Canadian stocks and mutual funds, and she has three kids! Family Trusts have become the favorite of Canada's rich for sheltering family wealth from the government. It's also a great tool for passing on appreciating capital assets to children and grandchildren, without triggering a deemed disposition/sale, (thus taxable capital gain) on the death of the parent or grandparent. One last thing on family trusts, CRA has recently been checking out exactly how this trust money is being spent. Remember food, clothing and shelter DON'T COUNT. The reasoning being that these expenses are difficult to pin down as to which child beneficiary received the direct benefit. RevCan clearly states that "any amount allocated to a child beneficiary of a trust MUST vest indefeasibly to that beneficiary". In other words that child better get the sole benefit of that money.
Personal Investment Holding Companies - Example: Mr. & Mrs. K. have a non-registered investment portfolio worth 1.3 million dollars, and rising. It tends to produce $100,000 in investment income, (dividends & capital gains) every year. The K's typically pay around 48% in total taxes on this money. The K.'s have two kids aged 18, 20. They are both undergraduates in university and Mrs. K. is not employed, and has no income. The K.'s setup an investment holding company called Holdco Inc. and rollover the portfolio into it. Here's how the investment income is taxed under Holdco:
Therefore, if the K.'s pay each adult child and Mrs. K, $23,000 in dividends, and the children have no other income; then the total taxes that will be paid on the K.'s investment income is $26,000. Thus, the Holdco has saved them $22,000. I'd take that.
(1) - Dividend refund is equal to the lesser of: the balance of Holdco's refundable tax on hand AND 1/3 of the dividend Holdco paid out, ( $74,000 x 1/3 = $24,667 ) |
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