Not too long ago our federal government changed the rules on the taxation of dividends. At the time they pitched the new rules almost as a benefit to Canadian taxpayers in that part of the change involved an increase to the dividend tax credit.
There was, however, a catch in that the amount by which dividends are grossed up when added to taxable income was also increased. Still, for most this would be relatively neutral in that the increase in the tax credit would offset the increase in taxes payable.
So why did they bother? A possible answer is that for some the change is significant in the way that it affects eligibility for government benefits, such as Old Age Security. Under the new rules it is more likely that a retiree’s OAS will be clawed back, since ‘claw-back’ is based on taxable income, which will necessarily be higher under the new rules for those earning dividend income.
This presents a bit of a dilemma since dividend-paying stocks have served many investors well over the years, and are typically considered prudent for relatively conservative investors in search of income.
Luckily there are ways for investors to get around these new rules.
One strategy involves the use of corporate class shares. These pooled investment products are similar to mutual funds, but are structured differently.
Specifically, mutual funds are structured as trusts, meaning that if a mutual fund holds stocks that pay dividends, the tax impact would be similar to holding the actual stock, in that the dividend income would flow through to the investor.
Corporate class shares, on the other hand, are structured as corporations. Dividend income, therefore, is taxed at the corporate level and does not flow through to the investor. Instead the value of the corporate class shares increases, and for the most part is only taxed upon redemption of the investment. And at that point, as a capital gain rather than dividend income — resulting in a much lower inclusion rate. Rather than being grossed up by 44 per cent (as is the case with dividend income), only half of a capital gain is included in income.
Another feature of corporate class shares involves how distributions can be paid to those who require income from their investments. Without getting into technical detail, healthy distributions can be paid, and classified as return of capital, which essentially means no taxation today.
Sooner or later, as they say, the piper must be paid. But in the case of corporate class shares, you have considerable control over when that taxable event will occur, allowing you time to plan in advance.
There are several other advantages to corporate class shares, and there are strategies involving insurance, charitable gifting, etc. that can be used effectively in conjunction with them. For more information please feel free to call or email.
Jim Grant, CFP (Certified Financial Planner) is a Financial Advisor with Raymond James Ltd (RJL). This article is for information only. Securities are offered through Raymond James Ltd., member Canadian Investment Protection Fund. Insurance and estate planning offered through Raymond James Financial Planning Ltd., not member CIPF. Commissions, trailing commissions, management fees and expenses all may be associated with mutual funds. Please read the prospectus before investing. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated.
For more information feel free to call Jim at 250-594-1100, or email at email@example.com. and/or visit www.jimgrant.ca.