Investing Through Appropriate Vehicles
There are various strategies employed by investors
when it comes to growing an investment portfolio. However, the goal of
investing is increasing the valuation of the portfolio and increasing the
overall rate of return for the individual. However, taxation impacts the rate
of return for the investor and is required to be remitted to the government based
on the capital gains or investment income realized. Therefore, for an investor
looking to deploy capital and invest surplus funds or savings in the stock
market, it important to determine what vehicle is ideal for the investor to
mitigate the tax exposure and increase overall net worth for the investor.
Investing Personally
When it comes to investing personally, it needs to
determined what type of activity will be carried out. For example will active
trading be done, or passive capital gains will be realized over time, or
seeking dividend or interest income. All of these impact how the income will be
taxed by the investor.
Registered Accounts – TFSAs and RRSPs
TFSA
TFSAs are a great way to invest funds in a tax effective
manner. The tax free savings account is an investment account for which any
income generated (interest, dividends, or capital gains), when realized are tax
free within the account. Therefore, you are investing after tax dollars and
investing in this account to tax advantage of the non-free benefit. Please note
that any contributions into this account are NOT tax deductible like the RRSP. TFSAs
have contribution limits, which are as follows:
2009 – 2012: $5,000 per year
2013 – 2014: $5,500 per year
2015: $10,000
2016 – 2018: $5,500 per year
2019 – 2020: $6,000 per year
When funds are withdrawn from the TFSA, the amount withdrawn is added to the contribution limit in the next taxation year.
In terms of tax, there is one caveat. If active trading is planned to be carried out, this can result in a negative tax consequence. The CRA can assess that activity as active trading income and considered business income and would be taxable. As such, if active trading is to be done, another vehicle personally or through a corporation should be used to carry out trading activity which will be discussed later.
RRSP
When you contribute to this account, the benefits include a tax deduction on your income in the year of contribution. This is beneficial since you are reducing your current income taxes and deferring taxes until you withdrawal from your RRSP (generally in retirement when your income levels are lower), thus in concept this makes sense to maximize this investment account should you be planning on withdrawing the funds when you can guarantee your income levels are a lot lower in retirement. Essentially, this a vehicle to defer taxes on earned income and defer taxes on investment income earned in the RRSP account.
Your yearly contribution room is based on a calculation which factors in your earned income for the year and a rate is applied of 18%. Also, after you file your annual tax return and receive a notice of assessment, CRA also calculates your contribute limit for you. The limit is 18% of your earned income or the CRA limit for the year (i.e., $27,830). Any un-used contribution room carries forward. You can also transfer your contribution room between spouses by opening up a joint spousal RRSP.
In terms of trading in an RRSP, there is a certain exemption on trading income derived from qualified investments which include most stocks listed on a designated stock exchange and other items.
Investing through a Corporation
Using a corporation is a great way to invest once the TFSA and RRSPs are maximized. Also, the nature of the income earned would impact the tax liability. For investors that are day trading, a corporation would allow for lower taxation as it is generating active business income. For investors seeking passive income, there are various other strategies that can be employed through the use of the company.
Trading Income
For investors that are actively trading, a corporation will prevent the exposure of being taxed personally through a TFSA. Also, taxes can be deferred through the use of the corporation. Active business income up to $500,000 is taxed at a lower rate of 12.25% and above $500,000 at 26.5% in Ontario. If an investor is trading actively, then the trading income would be subject to tax in the corporation at the rates noted. An analysis should be done as the CRA will review multiple items to make an assessment on the nature of the trading income as either business income or capital gains.
Passive income
Passive income such as dividend, interest, and capital gains income will be taxed by a Canadian corporation at a higher rate due to Part IV tax. As such it will not result in a tax deferral and is similar to personal at a high marginal tax bracket. There are strategies that can be utilized to mitigate the tax exposure in a company earning passive income; however, it is more complex for the context of this article.
Summary
As such, tax is an important factor to ensure that the investors overall rate of return is higher. Investment style, strategies and goals impact the tax treatment of the profits earned by the investor. However, there are various vehicles available for the investor to ensure that taxes are deferred and the investors net worth is increased. Each investor’s scenario is different, an analysis should be done and should speak to an expert over at MP Group to learn more.