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Issue: #114
October 2011 |
NEWSLETTER
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Greetings! This monthly Newsletter provides business, financial planning and tax information to clients and friends of our firm. Any of the general information contained in this Newsletter should not be acted upon without first determining its application to your specific situation. Contact our office if you have any questions or concerns. |
RRSPs -- ARE THEY AS GOOD AS THEY SAY? | |
RRSPs are one of the most popular retirement vehicles for Canadians. Being one of the few tax breaks you can take without the risks of a tax challenge is the main reason they enjoy most favoured status.
RRSPs provide a tax deferral - taxes are saved today to be repaid later. The government wants you to save to reduce the need for them to support you in retirement. The plan is to provide the tax break to motivate you to save. Good for the government, but is it good for you?
The tax break you receive today depends on your tax bracket. If you are in the lowest tax bracket, you get a refund of about 22% of your contributions. Individuals with higher income persons get as much as 46%. The tax you pay on withdrawal depends on your tax bracket at the time. Assuming current rates continue in the future, the tax you pay ranges from 22% to 47%. Make sure you do not get trapped into getting a current deduction at 22%, only to pay tax later at 47%. You have to generate a high level of investment returns to offset the 25% you threw away. Getting a tax deduction at 47% starts you off even.
Favourable capital gains tax rates, and the special rates on dividends, will also affect your decision. Money withdrawn from RRSPs are taxed as ordinary income - there are no creditsor deductions available (with the exception of a small pension credit generally for people over 65). Capital gains earned outside an RRSP are taxed at one half the normal rate - the highest rate possible is only 23%. Dividends attract a higher rate of tax with the maximum being 33%.
These special rates are lost in an RRSP. The capital gains and dividends are converted to ordinary income and subject to tax at your normal rates.
Here is one example of an RRSP contribution. Let us assume a person in the 23% tax bracket earns $20,000 today (and has the after tax amount of $15,400 available to invest) and has a choice of contributing his net pay of $15,400 to an RRSP, or investing elsewhere. In either case, the investments generate a 20% return on investment consisting entirely of capital gains. The individual withdraws the amount in four years when their marginal tax bracket increases to 47%. Here is what was made on a cash basis:
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Initial contribution
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$15,400
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Tax refund
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3,542
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Growth in RRSP @ 20%
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3,080
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Growth in value of tax refund @ 20%
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708
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Taxes on growth of tax refund @23%
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(163)
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Taxes on withdrawal of RRSP @ 47%
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(8,686)
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Net cash at the end
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$13,881
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In this case, the individual lost $1,519 despite earning 20% on their investments! What happens if the RRSP contribution is not made and the same investment returns are made?
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Initial capital invested
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$15,400
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Growth in investments
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3,080
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Capital gains tax - 23% of $3,080
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(708)
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Net cash at the end
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$17,772
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Not contributing to the RRSP produced an extra $3,891 in cash. The lesson here is to plan your RRSP contributions with some thought. Consider your present and future tax rates, the types of income you expect and the length of time you plan to leave funds in the RRSP. As you can see, RRSP contributions are not always the best option.
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PROTECTING BUSINESS WEALTH
FROM CREDITORS | |
Protecting assets from loss is fundamental to business planning. Risk of loss from creditor claims increases as a business grows in value. Failure to comply with contracts, accidents and negligence are examples where claims arise. The decision to proceed with a claim is influenced by the ability to obtain financial damages. The higher the company value, and the availability of assets, the more likely a lawsuit will start. Once started, it is virtually impossible to shelter the exposed assets from the claim.
Various steps are available to reduce risk of loss. A holding company owned by shareholders, which owns the corporation conducting business, is a common way to separate investment and business assets. As the operating business grows in value, the wealth is transferred to the holding company - usually by paying a tax free inter-corporate dividend.
We have done many corporate reorganizations to protect client wealth. If you need help contact us.
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YOU THOUGHT A RECEIPT WAS GOOD ENOUGH?
LOOK AGAIN!
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CRA has a broad idea of what is needed to support expense claims. In every day practice they usually do not look beyond the basics - the general ledger, financial statement and supporting records, including supplier invoices. However, if they choose, they can ask for additional information relating to anything that affects your financial results. What can they ask for? The key is the meaning of adequate books and records which is used in most tax legislation.
One section of the HST legislation defines the word "record" to include "an account, agreement, book, chart or table, diagram, form, image, invoice, letter, map, memo, plan, return, statement, telegram, voucher and anything else containing information, whether in writing or in any other form". They chose not to define the word "information" but defined the term "document" to include "money, security and a record." Nothing obvious ruled out here!
Despite the broad wording of the law, do not be worried about saving every scrap of paper or making records of all your phone calls. Get the information that is reasonable in the circumstances. Be sure to obtain original receipts and keep all your credit card transaction receipts. If you have doubts about the acceptability of documentation, take the extra step of getting additional supporting documents. As long as you can support your claim with sufficient evidence, you will seldom have a problem.
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