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Tax Strategies for a New Year

27/01/2016


This article was printed in the January – February 2016 issue of Signals the New Car Dealers Association of BC NCDA magazine.

As we enter into 2016 and with a new government in place, it’s fair to say we can expect some changes. A cornerstone of the Liberal platform was to make changes to the tax system and top of the list is reducing the tax for the middle class and increasing tax for high income earners. This means the top tax bracket will have a higher tax rate. At the time of writing this article, these rate changes are still speculation. Perhaps by the time this reaches our readers, we will have a better idea as to exactly what these changes are. The good news is that there is still opportunity for high income earners to consider strategies to deal with the increased rates.

For several years, rates in B.C. have been very stable, but we have seen the top tax rates creep up more recently. The table below indicates this trend:

                                           2013      2014 / 15    2016 (speculated)
Wages                                43.8%     45.8%         47.7%
Ineligible dividends             33.8%     38.0%         40.6%
Eligible dividends               25.8%      28.7%         31.3%
Capital gains                      21.8%     22.9%          23.8%

The days of viewing Alberta as somewhat of a tax haven are officially over, as their trend has increased even more significantly:

                                          2013       2014 / 15    2016 (speculated)
Wages                               39.0%       40.3%        48.0%
Ineligible dividends            27.7%       30.8%        40.2%
Eligible dividends               19.3%       21.0%        31.7%
Capital gains                      19.5%      20.1%        24.0%​

Fortunately, there are some strategies we can employ to effectively manage these increased rates. The most obvious one may seem a bit counter intuitive as it results in a prepayment of tax. This involves pulling income that would otherwise be taxed in 2016, into 2015. As we are now into 2016, one would hope you had this discussion about this with your advisors, but let’s take a closer look to see how much you are actually saving.

If, for example, you accrue a bonus in your company in 2015 and pay it out in 2016, you may consider reporting the income in 2015 and paying tax at 45.8% instead of 47.7%. Let’s speculate that the highest federal bracket will kick in at $200,000 of income and your typical annual income is $500,000. A pre-payment strategy would be to report a wage of $800,000 in 2015 and $200,000 in 2016, rather than $500,000 in each year. You would pay additional tax of $137,400 now, instead of $143,100 a year from now, thereby saving $5,700. Of course, you need to consider the cost of money, that is, whether you actually have to borrow to pay that tax bill or what may be the lost opportunity of investing it for a year. If we assume your interest rate is 3.25% and your corporate tax rate is 26%, the after tax cost is 2.4% which, in the example above, amounts to $3,300. This reduces the savings from $5,700 to $2,400. Not very exciting, is it? If you assume that you could have invested the money at an after tax rate of return of 4%, the tax saving is almost entirely eaten up by lost earnings. If you are remunerating yourself through dividends, the savings on prepaying taxes is a little better. A $300,000 eligible dividend taken in 2015, instead of 2016, would result in a prepayment of $86,100 and a savings of $7,800. If instead you invested the $86,100 at an after tax rate of return of 4%, you would have earned approximately $3,500, making your net saving $4,300.That might not seem like an impressive number, but it’s still money in your pocket.

There are, however, more advanced strategies that can save you significant tax. These strategies play off the rate differential between capital gains and dividends. In 2016, the speculated rate for capital gains is 23.8%, whereas the rate on eligible dividends is 31.3%. Simply put, if you are able to receive income as a capital gain instead of a dividend, you will pay much less tax. And if you are able to structure it as a corporate capital gain rather than a personal one, the savings will be even more significant. This of course, is easier said than done and depending on the nature of the strategy you use, the CRA could apply the general anti-avoidance rule (GAAR) or utlilize other tools to block your plan. Let’s assume, however, that you employ a strategy that isn’t “abusive”. For example, where you have a legitimate business reason for transferring assets from one company to another and in doing so you trigger a capital gain. The cost of receiving $100,000 personally after tax using this strategy is $19,000 versus approximately $46,000 if the same amount was received as an eligible dividend.

A professional tax consultant will be able to walk you through the strategies available to you and create a customized plan that allows you to minimize exposure and capitalize on every opportunity while remaining compliant to your tax obligations.

Darrell Endresen, Business Advisor, Assurance and Automotive, MNP LLP. Darrell can be reached at 604-949-2101 or via email at [email protected].