Here are some tax planning ideas to provide you some relief by reducing or recovering tax during this downturn in the economy while your assets and investments may be at lower values.
LOSS SELLING: (to reduce or recover tax)
Individuals, Companies, Trusts, Partnerships
- Consider triggering some losses: on investments and re-invest in similar securities (if it makes investment sense) to reduce or recover capital gains tax paid in the last 3 years (or gains in 2020).
WATCH – the loss may be denied or suspended if you sell to an affiliated person or if you are not “out of the market” for more than 30 days.
Individuals and Trusts: An affiliated person (your spouse, a company you or our spouse control, the family trust) cannot buy back the same security or own the same security within 30 days of the sale otherwise the loss is denied. The loss is also denied if you transfer the investment to your TFSA, RRSP or RRIF.
Companies: The company (and affiliated persons such as another company in the group, a controlling shareholder or his/her spouse or the family trust) cannot buy back or own the same security within 30 days otherwise the company has to wait to recognize the loss when the affiliated group no longer owns that security.
WATCH – capital losses reduce a company’s “Capital Dividend Account” (“CDA”) balance so please discuss with your DMCL tax advisor whether it 1st makes sense to pay a tax-free capital dividend from CDA before selling at loss.
- Investment Loans: If all or a portion of a loan you made (whether an interest bearing loan or a loan you made to your company) will likely not be fully or partially collectible, consider electing to claim a bad debt loss for the portion unlikely to be collectible. Similarly, if all or a portion of the interest cannot be collected (or unlikely to be collectible) you may be eligible to claim a reserve or bad debt for this also to reduce income for tax purposes. We encourage you to discuss this with your DMCL tax advisor.
- Transfer unrealized losses to your spouse: if you have investments that are down in value and your spouse has capital gains (whether this year or the last 3 years). You may be able to transfer your unrealized capital loss to your spouse by selling the investment to your spouse for cash or an interest bearing loan (see section 3 for “Investment Family Loans” for a 1% interest loan).
Watch – your spouse must own the investment for at least 30 days (consider if that makes investment sense).
INCOME SPLITTING WITH FAMILY MEMBERS: (to reduce family taxes)
To reduce the family’s taxes by shifting income from a higher income earner to a lower earner.
- 1% Interest Loans:
Starting on July 1, 2020, CRA’s prescribed rate is dropping from 2% to 1%. It never goes lower than this. Tax strategies to take advantage of this include:
- Investment family loans: One family member lends to another
A family member in a higher tax bracket could make a 1% interest loan to a spouse or minor child (typically using a trust). The loan must be documented and the borrower must pay interest no later than January 30th EVERY year otherwise the income or gains on that investment will being taxed back in the lender’s hands and no tax will be saved. A loan to an adult child does not have to be interest bearing but is a good idea in case all or a portion of the loan cannot be collected and you want to be able to claim a tax loss for that uncollectible portion (see commentary above). See our blog from January 2018 for more information.
Note: if there is an existing family loan that was made at higher than 1% then consider having it repaid and a new loan made or talk to your tax advisor.
Example: Sarah’s income is $250,000 so she is in the top tax bracket (in BC now 53.5%). Pat, (her spouse) earns $50,000 per year (28% tax bracket) works part time while their children are school age. If Sandy lends Pat $100,000 at 1% interest then any return Pat makes over 1% is taxed in Pat’s hands. If Pat makes, say, a $20,000 capital gain on the investment then they will save family tax of approximately $1,500 (up to $4,800 if Pat has no other income) and more with the reinvested capital or income. If Sarah and Pat have a family trust then there is more flexibility and potential ongoing tax savings.
- Company makes a short term loan to a shareholder or employee:
CRA’s prescribed rate is also the rate used for the interest benefit on corporate loans to a shareholder or employee if a shareholder or employee temporarily needs funds, the company could make a temporary loan (rather than pay a dividend or bonus).
WATCH: Shareholder loans (whether to a shareholder or their family member) must be repaid before the company’s 2nd year-end otherwise the amount of the loan is included in the borrower’s income for the year the loan is made.
Family Members as Shareholders
- Multiply the capital gains exemption: to reduce or eliminate capital gains tax on a future share sale. If you have an operating company, the Tax on Split Income Rules (“TOSI”) that otherwise take away income splitting tax benefits does not apply to the enhanced capital gains exemption when selling qualifying company shares. Talk to your DMCL tax advisor on effective ways to make a family member a shareholder (while values may be lower) to avoid pitfalls and for whether a family trust should be used.
- Dividends or Salaries: There are still opportunities to pay dividends or a salary* (company can only deduct the reasonable portion and impact on CERB) to lower income family members without TOSI applying. These rules are complex and are still relatively new and being interpreted. See our blog.
ESTATE PLANNING: (to reduce your Estate’s taxes and probate fees)
While values are lower:
- Freeze: The value of your investment in shares of a family company or in other capital investments (i.e. securities, real estate) and transfer or share the future upside with family members – whether directly or through a family trust. This may reduce your capital gains tax when you pass, reduces probate fees, initiates succession planning and may provide some income splitting on dividends (watch TOSI) and a family member’s capital gains exemption on a possible future sale.
- Refreeze: Reset a previous FREEZE to change how future growth/recovery is shared among the shareholders.
- Capital Gains Exemption: Consider purifying the company to remove excess investments whether to individual shareholders (either as dividends are to repay shareholder loans) or to an affiliate company while values are low (even if it means tripping a gain) in order to minimize tax consequences to the shareholders. The shares may then be able to qualify for the capital gains exemption and steps can be taken to trigger a gain to bump the tax cost of the individual’s shares and reduce eventual tax when the shares are sold or the individual passes. There can be tax savings of up to $235,000. * Note: Alternative Minimum Tax may apply.
WRITE-DOWNS: (to reduce or recover income tax)
While values are lower:
- Overvalued Inventory? Take a closer look and see if some inventory is overvalued and should be written down for tax (and accounting) to claim a deduction for tax purposes.
- Professionals’ Work In Progress (“WIP”): Consider “cleaning up” overvalued WIP for by writing it down or taking an allowance taken for the portion that will unlikely be billed or collected.
- Receivables: Review receivables and claim a reserve for doubtful accounts or write-off all or a portion of debt unlikely to be collected to claim a deduction for tax purposes.
- Depreciable Assets: If any are no longer in use, are obsolete or now worthless, a terminal loss (tax deduction) may be available.
USE LOSSES WITHIN THE CORPORATE GROUP: (to reduce or recover income tax)
- Transfer appreciated capital assets to an affiliated company with losses: (e.g. real estate) electing under subsection 85(1) for tax purposes to recognize the gain in the loss company. WATCH: tax savings benefit will be lost if the transfer is to an unaffiliated person or company and the transferee sells the assets within 3 years of the transfer. CONSIDER: commercial risk of transferring to a loss company or the cost of tripping other taxes (e.g. property transfer taxes, PST).
- Loans within the group: One member of the group could make a secured loan to another member with losses to invest in assets that it could lease or rent to other members of the group to create taxable income for the loss company and create tax deductions for the profitable company.
- Reorganize corporate groups: if one company has losses and the other is still profitable, consider reorganizing the group (generally tax-free) by merging or winding up one of the companies into the other after consulting the group’s legal counsel. If for commercial reasons, the groups should stay separate, consider a limited partnership structure.
See our website for personal and business economic help.
OTHER TAX CREDITS:
Some of the valuable tax credits available that may result in a tax refund include:
R&D – Scientific, research and experimental development (“SR&ED”) tax credits: Up to 41%!
Did your business have to pivot and innovate whether or not because of COVID-19? It may be eligible for Federal and BC SR&ED tax credits if there was some science or tech uncertainty and advancement. The credits are worth up to 41% of eligible SR&ED expenditures incurred including 155% of salaries and wages paid to employees directly engaged in SR&ED activities.
30% BC Tax Credit for BC Individuals and Companies – Investing in BC Venture Capital Corporations/BC Eligible Small Businesses:
For approved investments in BC Venture Capital Corporations or BC Eligible Small Businesses
BC resident individuals and companies are eligible to claim a 30% BC tax credit on these investments. For individuals, the tax credit is refundable up to an annual maximum of $120,000.
For further information on how these strategies can apply in your particular circumstances, please contact your DMCL Advisor.