Taxation and Shelter of Investment Income

Taxpayers who are looking for a place to invest income or savings, whether within a registered plan or outside of one, are faced with a bewildering array of options from which to choose. As well, new and often increasingly complex investment vehicles seem to be offered in the marketplace on an almost daily basis.

It isn’t often that the tax aspects of a transaction are the easiest part, but the basic tax rules with respect to investment income can actually be relatively straightforward. While variations within each category abound, most investment income (except in certain specialized industries) can be characterized as falling into one of three categories of income — interest, dividends, or capital gains.

An important caveat: it’s an old tax truism, but still a valid one, that tax considerations alone should never drive an investment decision. While the tax treatment of income (or losses) arising from an investment can and should figure into the decision of whether and how much to invest, those considerations should always be secondary to the perceived worth of the investment, independent
of any tax consequences.

All investment income, from all sources, is taxable. That said, some types of investment income may provide a better after-tax return than others, through lower inclusion rates, special credits, or
other beneficial tax treatment. See the links below for the tax impacts on each type of income:

  • Interest Income
  • Dividend Income
  • Capital Gains and Losses

Sheltering investment income from tax

An announcement made in the 2008 federal Budget will give Canadians an unprecedented opportunity to make investments and earn investment income on a tax-free basis. While Canadians can currently invest funds in tax-deferred savings vehicles — Registered Retirement Savings Plans and Registered Education Savings Plans being the best known — any investment income earned within such plans is eventually taxed on withdrawal. Such is not the case with the Tax-Free Savings Accounts (TFSAs).

Beginning in 2015, each Canadian resident over the age of 18 is eligible to invest $10,000 ($5,000 prior to 2015) per year in a TFSA, and investment income of any type earned in such accounts
will be tax-free, both on a current basis and on withdrawal. Where (tax-free) withdrawals are made from a TFSA, the account holder will be permitted to re-contribute the amount withdrawn, either in the current year or any future year. As well, where contributions are not made in any year, or less than the maximum contribution is made, any unused contribution room is carried forward indefinitely.

While the $10,000 amount which may be contributed to a TFSA each year may be relatively small, the ability of contributed funds to compound on a tax-free basis within the account creates the potential for significant capital accumulation over the long term.

Conclusion

It is apparent from the foregoing that the nature of an investment can have a significant impact on the after-tax return enjoyed by the investor, owing to the different tax treatment accorded different types of investment income (or, less optimistically, investment losses). However, the caveat outlined at the beginning of this article bears repeating: no investment should be undertaken or refused solely, or even primarily, because of the perceived tax benefits; it is the value of the underlying investment that should in all cases drive the investment decision.

A further caveat: at any given time, there are investment vehicles being promoted in the marketplace that purport to offer extraordinarily beneficial tax treatment and, thus, a significantly better after-tax return. However, the Canadian tax net is a comprehensive one, and offers that seem too good to be true generally are. In all cases, professional investment and tax advice are warranted where significant investment decisions are being weighed.

The articles posted here provide information of a general nature. These articles should not be considered specific advice; as each vistor’s personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in these articles.

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