The Financial Advisor Guide to Taxation

The Financial Advisor Guide to Taxation

Self-Study Course # 5

OVERVIEW

Upon completion of this course, you will be able to understand which income sources constitute earned income. You will study tax deductions and tax credits, and how they will affect your clients and prospects net income. We will look at how indexing can affect an individual’s tax situation. You will be in a better position to tell the difference between being an employee of a company, and being self –employed and at the same time know what deductions and write offs are available to your clients and prospects who arein a similar situation.

The complex taxation of Life Insurance, Annuities, RRSP’s, and Variable Contracts will be studied in a way that makes it simple to understand. You will have a working knowledge of Capital Gains, Capital Losses and the nuances of Canadian taxation.

Where possible, we have updated the Taxation Rules & Regulations to reflect any changes for the 2015 and 2016 Tax years.

INTRODUCTION

Today, it is reasonable to believe that high taxes are here to stay. With the growing cost of government social services, high government indebtedness, and the high cost of infrastructure, we find ourselves being taxed at very high rates. To add to this, the taxation laws and regulations are forever changing.

As an Advisor, Agent or Broker, you must develop a good working knowledge of the Canadian taxation system as it applies to the products and advice that you provide.

Some of these purchases could include Life Insurance, Disability Insurance, RESPs, RRIFs, LIFs, Annuities or savings and investment contracts. Employee benefits or Corporate Retirement Plans can also attract some form of taxation.

As their advisor, you are expected to know the general tax rules pertaining to each individual area. It is not necessary to get into the technical aspects of taxation with your clients or prospects, but knowing where to find the answers would be extremely beneficial to you as well as them. Remember that you are a part of their team that includes the Accountant (tax expert), and their Lawyer.

You may not have all the answers, but you must know who to refer them to.

LOOKING AT INCOME TAX IN A GENERAL WAY

Even though Federal income taxes were first introduced in 1917, the Income Tax Act has changed many times over the years. These changes are a direct result of changes in the government’s views on monetary and fiscal policy. Of course, over the past few years the change in the global economy has had a direct impact on our taxes as well.

The lion’s share of the government’s revenue comes from the taxes that you and your clients pay on a yearly basis.

The Canadian Income Tax rules and regulations are one of great complexity and constantly shifting emphasis. Much of our planning process, whether it is Financial Planning or Estate Planning, centres on how to minimize tax for our clients and prospects without breaking the law. With this in mind, we still have to gain the greatest advantage in the investments and other products that we market to our clients and prospects.

We must understand how Income Tax relates to their finances and investments as well as to the products we sell them. Even though we are not qualified to give tax advice, we must acquire a working knowledge of how it affects the market place we serve.

Income tax must be paid on income received after allowable deductions have been taken into consideration.

Individuals who are resident in Canada are liable for income tax on their worldwide income. Non-residents are liable on Canadian-source income (including income from employment in Canada and income from carrying on a business in Canada) and on capital gains derived from taxable Canadian property.

Residence means the jurisdiction in which a person regularly, normally, and customarily lives. Indicators of residency include: ownership of a home in Canada, whether other members of the individual's family reside there, and membership in clubs and associations in Canada. Individuals present in Canada for periods totalling 183 days or more may be deemed resident.

The acquisition of permanent resident status for immigration purposes is a significant factor. Citizenship has little or no relevance to the question of residence for tax purposes.

Individuals becoming residents are generally deemed to have acquired all property, other than taxable Canadian property, owned at that time at a cost equal to the current fair market value. Individuals ceasing to be resident are regarded as having disposed of their property, other than taxable Canadian property, at its current fair market value.

Taxable Canadian property for this purpose is defined as including:

Real property situated in Canada.
Most capital property used in carrying on a business in Canada.
Shares of a corporation (other than a public corporation) resident in Canada.
Shares of a public corporation if, within the five years preceding disposal, the non-resident and persons with which the non-resident did not deal at arm's length owned at least 25% of any class of capital stock of the corporation.
An interest in a partnership if, at any time during the twelve months preceding disposal of the interest, the fair market value of taxable Canadian property held by the partnership constituted 50% or more of the fair market value of all the partnership property.
A capital interest in a trust (other than a unit trust) resident in Canada.
A unit of a unit trust (other than a mutual fund trust) resident in Canada.
A unit of a mutual fund trusts if, at any time during the five years immediately preceding the disposal, the non-resident and persons with whom the non-resident did not deal at arm's length owned at least 25% of the issued units of the trust.
Property deemed to be taxable Canadian property. For example, the owner of the property may make an election to that effect when he or she ceases to be resident in Canada. Security has to be provided to Revenue Canada to cover taxes that would otherwise be payable.

PERSONAL INCOME TAX RATES

Both the federal and provincial governments levy personal income tax. Provincial income tax is in most provinces is calculated as a percentage of federal income tax payable and is collected by the federal government on behalf of the province. For provincial income tax purposes, business income is apportioned between the provinces when individuals carry on business through permanent establishments in more than one province. Other income, however, is generally considered to have been earned in the province in which the individual resides at the end of the tax year, regardless of where it has actually been earned.

Federal Income Tax Rates

Canadian federal income tax is calculated based on taxable income, and then non-refundable tax credits are deducted to determine the net amount payable. For 2016, every taxpayer can earn taxable income of $11,474before paying any federal tax.

The basic personal tax credit is calculated by multiplying the lowest tax rate by the basic personal amount. The 2016 tax credit is 15% x $ 11,474 = $1,721.10.

The Department of Finance announced in November 2007 that the lowest federal tax rate would be reduced to 15%, and certain tax credits would be revised to compensate for the lower tax rates. The revised rates are being used on 2016 personal income tax returns provided by Canada Revenue Agency (CRA). The tables below have been revised to include the 15% tax rate and the basic personal exemption amount increase.

2016Federal Marginal Tax Rates

2016 Taxable Income / Marginal Tax Rates
Other
Income / Capital
Gains / Eligible
Dividends / Non-eligible Dividends
First $45,282 / 15.00% / 7.50% / -0.03% / 5.24%
$45,282 - $90,563 / 20.50% / 10.25% / 7.56% / 11.67%
$90,563 - $140,388 / 26.00% / 13.00% / 15.15% / 18.11%
$140,388 - $200,000 / 29.00% / 14.50% / 19.29% / 21.62%
Over $200,000 / 33.00% / 16.50% / 24.81% / 26.30%

Federal personal income tax breakdown

Statistics Canada recently published a study titled Federal Personal Income Tax: Slicing the Pie, which examines the breakdown of federal personal income taxes paid by high and low income earners in Canada. The data was merged with data from The Fraser Institute’s Canadian Tax Simulator to produce the following information.

Share of federal personal income tax paid

Incomegroup / % of federal personal
income taxes paid
1990 / 2011
50% with lowest incomes / 6.7% / 8.5%
40% with intermediate incomes / 47.3% / 43.4%
10% with highest incomes / 46.0% / 48.1%
All Canadian tax filers / 100.0% / 100.0%

Effective federal personal income tax rates

Income Group / Federal tax as % of income
1990 / 2011
50% with lowest incomes / 4.30% / 4.97%
40% with intermediate incomes / 11.75% / 9.83%
10% with highest incomes / 17.79% / 16.95%
All Canadian tax filers / 12.25% / 11.00%

Share of total income

Incomegroup / % of total income
1990 / 2011
50% with lowest incomes / 19.0% / 21.7%
40% with intermediate incomes / 49.3% / 47.4%
10% with highest incomes / 31.7% / 30.9%
All Canadian tax filers / 100.0% / 100.0%

Provincial/Territorial tax rates for 2016

Under the current tax on income method, tax for all provinces (except Quebec) and territories is calculated the same way as federal tax.

Form428 is used to calculate this provincial or territorial tax. Provincial or territorial specific non-refundable tax credits are also calculated on Form428.

Canadian federal and provincial/territorial income taxes are calculated separately, although on the same tax return, except for Quebec. The rates are combined here so that taxpayers can see the total tax rate being paid, including any provincial surtax.

The combined tax rates in these tables are marginal tax rates, including any provincial surtax. Other income would include any income from employment, self-employment, interest from Canadian or foreign sources, foreign dividend income, etc.

After the income tax amounts are calculated, non-refundable tax credits are deducted from the tax payable. Non-refundable tax credits include the basic personal amount, which is available to every taxpayer. A list of most of the non-refundable tax credits can be seen in the tables of federal, provincial and territorial non-refundable personal tax credits.

Top Combined Federal/Provincial Tax Rates — 2016

Combined Top Marginal Rate
Province / Provincial/Territorial TopPersonalRate / Other Income / Capital Gains / Eligible
Dividend
Alberta / 15.00% / 48.00% / 24.00% / 31.71%
British Columbia / 14.70 / 47.70 / 23.85 / 31.30
Manitoba / 17.40 / 50.40 / 25.20 / 37.78
New Brunswick / 20.30 / 53.30 / 26.65 / 36.27
Newfoundland & Labrador / 16.80 / 49.80 / 24.90 / 40.54
Nova Scotia / 21.00 / 54.00 / 27.00 / 41.58
Ontario / 13.16 / 53.53 / 26.76 / 39.34
PEI / 16.70 / 51.37 / 25.69 / 34.22
Quebec / 25.75 / 53.31 / 26.65 / 39.83
Saskatchewan / 15.00 / 48.00 / 24.00 / 30.33
NWT / 14.05 / 47.05 / 23.53 / 28.33
Nunavut / 11.50 / 44.50 / 22.25 / 33.08
Yukon / 15.00 / 48.00 / 24.00 / 24.81

Combined rates reflect the following provincial surtaxes:

Alberta – no provincial surtaxes.
British Columbia – no provincial surtaxes.
Manitoba – no provincial surtaxes.
New Brunswick – no provincial surtaxes.
Newfoundland – no provincial surtaxes.
Nova Scotia – no provincial surtaxes.
Ontario – 20 per cent applies when Ontario tax exceeds $4,484; 36% applies when Ontario tax exceeds $5,739.
PEI – 10 per cent applies when PEI tax payable exceeds $12,500.
Quebec – no provincial surtaxes.
Saskatchewan – no provincial surtaxes.
Northwest Territories – no territorial surtaxes.
Nunavut – no territorial surtaxes.
Yukon – no territorial surtaxes.

Note: All Canadian provinces and territories, except Quebec, have adopted a "tax on income" (TONI) system of calculating provincial personal income tax. Quebec continues to administer its own provincial taxes, as it has since 1954.

How Does Indexing Affect Our Taxes?

Inflation, a general rise in prices over time, creates problems for income taxation because it affects people’s purchasing power—their ability to buy goods and services. If people’s income and the general level of prices both increase at the same rate over time, then people’s real income—the amount their income will buy—remains the same. In other words, if your income doubled, but at the same time all prices doubled because of inflation, you would be no better or worse off. However, unless special actions are taken, under the existing progressive bracket rate schedule, the proportion of your income taken by taxes would increase.

Increases in income due to inflation can push people into higher tax brackets, a phenomenon known as bracket creep.

In effect, inflation can increase people’s tax liability without any change in tax law.Amounts subject to indexing include the various personal credits, the tax brackets for individuals and the thresholds for repaying government allowances, such as the Old Age Security.

OAS Tax Figures (2016)
Threshold at which the middle tax rate begins to apply. / $45,282
Threshold at which the top tax rate
begins to apply. / $200,000
Threshold (Clawback) where Old Age Securitycommences to be repaid. / $73,756
Threshold where Old Age Security
is eliminated completely / $119,512
2016 Federal Personal Tax Credit Amounts
Basic personal amount / $11,474
Age amount (maximum) / $7,125
Amount for eligible dependant (maximum) / $11,474
Spouse or common-law partner amount (maximum) / $11,474
Amount for infirm dependent over age 18 (maximum) / $6,788
Pension Income (maximum) / $2,000
Disability amount (maximum) / $8,001

DETERMINING IF YOU ARE AN EMPLOYEE OR SELF-EMPLOYED?

Business Relationship or Employer-Employee Relationship?

Before you advise your clients and prospects in areas of taxation, you should determine which category of employment status they fall into. It helps to know whether they are an employee or self-employed.

This gray area has for some time been under scrutiny in our business. Most of us are commission salespeople. There is no gray area when you deal with your clients or prospects, they are either an employee, or self-employed.

It is important to know this information before making your financial recommendations. There may be some tax advantages that would be beneficial to be one way over another.

When it comes to taxation of income, the government has criteria that they will look at to see what type of income you have.

Canada Revenue Agency (CRA) will usually look at four key areas:

Control

As a rule, in an employer-employee relationship, the employer will control the way that work is done and what methods are used. Specific jobs are assigned, as well as the way in which the job is to be done. If an employer does not directly control the employees, but still maintains the right to do so, control will still exist.

The Employer may control:

Work hours.
Quality of the work to be done.
Any reports submitted to the employer.
Any client lists and territories covered.
Any training and development.

If a business relationship exists, the employer will not usually have any control over the employee’s workday. The employee is left on their own to decide how and what work will be done.

Ownership of Tools
The amount for tools invested,
Values of equipment and tools,
Rental and maintenance of equipment and any tools.

In an employer-employee relationship, the employer will usually supply any equipment necessary for the employee to do their work. Costs such as any repairs, rentals, and transportation are also usually at the expense of the employer.

In a business relationship, tools and equipment are supplied by themselves.

If an employee purchases any tools or equipment necessary to do their job, it is at their own expense because they are self-employed perhaps contracted individuals.

Chance of Profit or Risk of Loss
Does the employee / worker have any chance of making a profit?
What are any risks leading to losses from bad debts, damage to equipment or materials or any delivery delays?
Who covers the operating costs?

In an employer-employee relationship, the employer alone would assume any risk of loss. An employee is entitled to receive his full salary or wages regardless of how much a company earns or loses. In a business relationship, self-employed individuals could profit or have a loss. They cover any operating costs alone.

Integration

This area looks at the possibility of looking at the first three areas and not being able to determine what your status is. As a rule of thumb, a business relationship will exist if the worker can integrate his or her own activities with the employer’s activities. This would mean that the worker is acting on his or her own behalf. They are not dependent on the payer’s business and he is in business for himself.

If on the other hand, the worker can integrate their activities to any commercial activities of the payer, there is a good chance that an employer-employee relationship will exist. This means that the worker is connected with the payer’s business and dependent on the employer’s business.

In order for an employer-employee relationship to exist, the employer must:

Register with Canada Revenue Agency to acquire a Business Number (BN).
Withhold income tax, CPP or QPP contributions, and Employment Insurance (EI) premiums.
Remit the withheld as well as any required employer’s share of contributions to Canada Revenue Agency on an ongoing basis.
Report the employee’s income and deductions on the appropriate returns.
Give the employee T4 slips by the end of February of the following year.
Register with Workmen’s Compensation.

In order to have a business relationship, when the self-employed worker’s income exceeds $500 or any income tax has been deducted, the payer (employer) must:

Report any self-employed individuals’ income and tax deductions to the Revenue Canada Agency (CRA).
Provide the self-employed with a copy of their T4A by the end of February of the following year.

Questions That Should Be Answered to Determine
Employee or Self-Employed Status
Payer / Worker / N/A
Who is responsible for planning the work to be done?
Who decides how and how much the worker is to be paid?
Who decides on any periods?
Who decides how the work is to be done?
Who decides on the hours of work?
Who decides on the location?
Who assigns the individual tasks?
Who supervises the tasks?
Who sets the standards to be met?
Quality?
Volume?
Time frame?
Who decides whether work must be redone?
Who covers the cost?
Who is responsible for training?
Who covers the related costs?
Who decides on the territory to be covered?
Who decides on periodic activity reporting?
Who decides if the work is to be done by the worker himself?
Who hires helpers?
Who supplies the heavy equipment or covers it rental cost?
Who supplies the specialized equipment or covers cost?
Who covers equipment maintenance costs?
Who supplies the large tools or covers their rental costs?
Who supplies the specialized tools or covers their rental cost?
Who supplies the small tools?
Who covers tool maintenance costs?
Who supplies the materials?
Who has invested in the equipment and tools?
Who covers the costs of damage to equipment or materials?
Who covers the costs of liability insurance?
Who covers the office expense?
Who covers the rental costs?
Who covers delivery and shipping costs?
Who covers costs related to bad debts?
Who assumes responsibility for ensuring that guarantees relating to materials are honoured?
Who guarantees the quality of work?
Who covers the costs incurred by the worker in carrying out the work?
Who covers the costs of the worker’s benefits (vacation, sick leave, life insurance premiums, etc.)?

Contract Employees