When Investments Pays Off!


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When Investments Pays Off!

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When Investments Pays Off!

  1. 1. Taxation of Investment Income WALI MEMONWali Memon July 05, 2010
  2. 2. The Elephant in the Room 2 Tax considerations are a factor all financial decisions. Our governments participate in almost every transaction in our lives…without negotiation or notice.Wali Memon July 05, 2010
  3. 3. Types of Taxes in Canada 3 Income taxes on both persons and corporations (both Federal and Provincial) Taxes on taxes (example is the ‘surtax’ in Ontario and the Health Care levy in Ontario) Estate taxes (probate – Provincial) Property taxes (municipal in both organized and unorganized townships – market value based) Consumption taxes (sales) GST, PST, HST Hidden taxes Excise taxes (taxes on products – gasoline, cigarettes, alcohol) - generally hidden in the purchase price of the product. Hotel room tax (in some provinces) Airport taxes (airport authorities) included in the price of the ticketWali Memon July 05, 2010
  4. 4. Key Concepts 4 Income Tax Act of 1917 – a temporary tax measure Canadians are taxed on their world-wide income 1972 – capital gains became taxable in Canada 1990s under Paul Martin, moved to raise tax revenue and cut Federal Spending: Removed indexing of brackets and deductions Converted most deductions to non-refundable tax credits Downloaded responsibilities to Provinces Progressive nature of personal taxation in Canada Social, economic and political objectives of the Income Tax Act Deferring income tax is beneficial to the taxpayer because of the time value of moneyWali Memon July 05, 2010
  5. 5. Personal Income Tax 5 You can access many resources from Canada Customs and Revenue Agency’s web site (including downloadable forms in PDF format) at: http://www.ccra-adrc.gc.ca/menu-e.html Check out the course website for refreshed linksWali Memon July 05, 2010
  6. 6. Personal Income Taxation 6 Income Tax Act self-assessment progressive marginal vs. average tax rates tax brackets tax credits vs. deductions Taxation of Investment Income interest dividends capital gains and lossesWali Memon July 05, 2010
  7. 7. Non-taxable Income 7 You do not have to include certain amounts in your income, including the following: any GST/HST credit or Canada Child Tax Benefit payments, as well as those from related provincial and territorial programs; child assistance payments and the supplement for handicapped children paid by the province of Quebec; compensation received from a province or territory if you were a victim of a criminal act or a motor vehicle accident; lottery winnings; most gifts and inheritances; amounts paid by Canada or an ally (if the amount is not taxable in that country) for disability or death due to war service; most amounts received from a life insurance policy following someones death; most payments of the type commonly referred to as "strike pay" you received from your union, even if you perform picketing duties as a requirement of membership; and Note Income earned on any of the above amounts (such as interest you earn when you invest lottery winnings) is taxable. most amounts received from a Tax-Free Savings Account (TFSA). For more information, see guide RC4466, Tax-Free Savings Account (TFSA).Wali Memon July 05, 2010
  8. 8. 2009 Marginal Rates of Income Tax No change in rates over 2008Bracketsadjusted FEDERAL TAX RATES:upward. Taxable Income Tax Rate $0 - $40,725 15% $40,726 - $81,451 22% $81,452 - $126,264 26% $126,264 + 29% ONTARIO - PROVINCIAL TAX RATES: Taxable Income Tax Rate $0 - $36,848 6.05% $36,849 - $73,698 9.15% $72,699 + 11.16%  36,848 − 36,020  Provincial ∆ =   − 1 = 2.29%  36,020   40726 − 37,885  Federal ∆ =   − 1 = 7.5%  37,885  July 05, 2010
  9. 9. 2009 Marginal Rates of Income Tax Federal Provincial Total Tax Bracket Rate Rate (Ontario) Marginal Rate$0 - 36,848 15.000% 6.050% 21.050%$36,849 -$40,725 15.000% 9.150% 24.150%$40,726 -$73,698 22.000% 9.150% 31.150%$73,699 - $81,452 22.000% 11.160% 33.160%$81,452 - $126,264 26.000% 11.160% 37.160%$126,264 29.000% 11.160% 40.160% NOTE: This ignores the substantial surtaxes in Ontario NOTE: SEE TABLE 3 -4 PAGE 96 OF THE BOOTH/CLEARY TEXT FOR TAXATION OF INVESTMENT INCOME. July 05, 2010
  10. 10. Marginal Tax Rate 10 That rate of tax you will pay on the next dollar of income. This is the rate you should use when making investment decisions…because investments lead to you receiving incremental investment income (dividends, interest or capital gains) It is the after-tax returns you will expect from your investment that are relevant for investment decision-making.Wali Memon July 05, 2010
  11. 11. When Might You Use a Marginal Tax Rate?Whenever you are evaluating an incremental decision:For example: When evaluating an investment decision to determine the net after-tax rate of return.For example if you want to find the marginal after-tax rate of returnon interest income of 10% Marginal After - tax rate of return on 10% interest assuming a 40% marginal tax rate : (1 - marginal tax rate) (1 − .40) .6 = = = = 6% interest rate .10 .1 July 05, 2010
  12. 12. Average Tax Rate 12 Equals = Net Taxes Payable/Taxable Income will always be much lower than your marginal tax rate because the first few dollars of taxable income are not taxed…the first $37,885 is taxed at the lowest federal rate…and so on...Wali Memon July 05, 2010
  13. 13. Tax Deduction 13 Is amount that you are allowed to deduct from income in the process of calculating your taxable income.Wali Memon July 05, 2010
  14. 14. Tax Credit 14 Is a direct reduction of tax otherwise payable.Wali Memon July 05, 2010
  15. 15. Total Income 15 Includes: Employment income 101 Other employment income 104 Old Age Security pension 113 CPP or QPP benefits 114 Disability benefits 152 Other pensions or superannuation 115 Elected split-pension amount 116 Universal Child Care Benefit 117 Employment Insurance and other benefits 119 Taxable amount of dividends from taxable Canadian Corporations 180 Interest Income 121 Support payments received 128 RRSP income 129 Other income 130 Workers’ compensation benefits 144 Social assistance payments 145 Net federal supplements 146Wali Memon July 05, 2010
  16. 16. Examples of Tax Deduction used in determining Taxable Income 16 Income: From employment $50,000 Net Business Income 10,000 TOTAL INCOME $60,000 Less Deductions: RPP $4,000 RRSP 8,000 Annual Union, Professional Dues 2,000 NET INCOME $46,000 Less Other Deductions: Northern Resident Deduction 1,000 TAXABLE INCOME $45,000Wali Memon July 05, 2010
  17. 17. Taxable Income 17 Is the ‘base’ upon which your personal tax liability is determined.Eg. In the lowest tax bracket: Federal Taxes = taxable income *15% = $10,000 * .15 = $1,500Wali Memon July 05, 2010
  18. 18. Tax Credits 18 Examples of Tax Credits: non-refundable tax credits (15 % of basic personal amount, age amount, spousal amount, CPP contributions, EI contributions, pension amount, tuition and education deductions, medical expenses…etc.) Donations and gifts (15% of first $200 and 29% on excess) Dividend Tax Credit Federal political contribution tax credit Labour-sponsored funds tax creditWali Memon July 05, 2010
  19. 19. Taxation of Investment Income 19 Investment income includes: interest dividends capital gainsWali Memon July 05, 2010
  20. 20. Taxation of Interest Income 20 interest is taxed at the person’s marginal tax rateWali Memon July 05, 2010
  21. 21. Taxation of Dividend Income 21 ‘eligible’ dividends are grossed up by 45% and included in income, then the taxpayer is allowed a dividend tax credit equal to 18.9655% of the taxable amount of eligible cash dividend ‘other than eligible dividends’ are grossed up by 125% and included in income, then the taxpayer is allowed a dividend tax credit equal to 13.3333% of the taxable amount of dividends reported.Wali Memon July 05, 2010
  22. 22. Taxation of Capital Gain Income 22 50% of a realized capital gain is subject to tax at the taxpayer’s marginal tax rate an allowable capital loss is 50% of the capital loss and may be used to offset taxable capital gains (carry back and carry forward provisions do apply.)Wali Memon July 05, 2010
  23. 23. Non-Taxable Income … 23 You do not have to report any of the following amounts on your return since these amounts are not taxable, and they do not affect any credits or deductions you can claim on your return. Do not report: the goods and services tax/harmonized sales tax credit; Canada Child Tax Benefit payments and related provincial benefits; lottery winnings; most amounts received because of disability or death that resulted from war service; Long-term disability insurance income as long as you paid the policy premiums out of after-tax dollars (employer did not contribute) most amounts received from a life insurance policy following someones death; or an inheritance. However, you do have to report any income you earn from investing these non- taxable amounts.Wali Memon July 05, 2010