For any investor it is very important to understand the types of income generated and the after-tax cash flows. Depending on the type of investment income, the tax rates can be different and should be considered before making an informed investing decision. Your accountant can advise on the tax implications regarding your investments.
Dividends received from a Canadian public corporation (eligible dividend), will be grossed up by 38% for 2012 when included into your income. However, eligible dividends will entitle you to a non-refundable federal dividend tax credit of 20.73% of the actual dividend. Most dividends from public Canadian corporations are subject to lower tax rates, in some provinces lower than capital gains. Eligible dividends may trigger alternative minimum tax. Consult your trusted accountant regarding the tax options available to you.
In Alberta, dividends from private Canadian companies are subject to a 25% gross-up and a 16.67% non-refundable federal dividend tax credit. This is applicable for dividends paid out of corporate income eligible for the “small business” tax rate. If the corporate income is ineligible for the “small business” tax rate (taxable corporate income over $500,000), this can be distributed as eligible dividends.
Dividends from foreign corporations are not eligible for dividends gross-up tax treatment, and are taxed the same as interest income. If foreign tax is withheld, you may be eligible for a foreign tax credit.
Interest on investments is included into your income on an accrual basis (received or receivable on each annual anniversary date). Interest income is included 100% into your income; there is no non-refundable federal tax credit available. Premium received on treasury bills, stripped coupon bonds or other discount obligation must be reported as interest income.
Capital gain or loss is computed as the difference between the tax cost base and net proceeds from the sale of capital property (i.e. investments). Only 50% of the capital gain or loss is included in calculating your income. Capital gains may trigger alternative minimum tax. Consult your trusted Chartered Accountant regarding the tax options available to you.
If your capital losses for the year exceed your capital gains, the excess loss is available for carry back or forward. You can carry back your capital losses three years and apply them against taxable gains for those years. This allows for recovery of tax previously paid on capital gains. Any amount not carried back will be available indefinitely to shelter future capital gains. Capital losses have the same inclusion rate as capital gains – 50%.
Since capital gains are eligible for 50% income inclusion rate, it is preferable to receive capital gains treatment rather than full income inclusion. Frequent investment traders may be taxed on income account, and may not be eligible for the preferential capital gains treatment.
You may elect to have any gain (or loss) realized on the disposition of Canadian securities treated as a capital gain (or capital loss). File “Election on Disposition of Canadian Securities” form T123 with your personal tax return for the year. As a result, all gains and losses on the disposition of Canadian securities are treated as capital gains and losses, rather than trading gains and losses. Once filed, this election is irrevocable.
The election does not apply to transactions made by a trader or dealer in securities.
You may be able to claim a capital gains reserve for proceeds on the sale of capital property due on a promissory note in a later year. However, you must include the capital gains in income over a period of up to five years, at a minimum cumulative rate of 20% of the taxable capital gains per year. This general reserve rule is extended to 10 years for dispositions to children or grandchildren living in Canada.
The capital gains reserve is available for proceeds receivable in a later year but not as a demand promissory note – in this case the note is considered to be due immediately (and the entire gain reportable in the year of disposition).
If proceeds are not due until a later year, you should plan to have enough cash on hand to pay the taxes due each year during the capital gains reserve period.
Income tax can represent a substantial cost on your investments. Consider discussing with your accountant your after-tax returns when evaluating investment options.
Your trusted Chartered Accountant provides services regarding taxation of various types of investment income.