Investment income includes income you receive as a result of ownership of property. The property could, for example, be shares of a corporation, bank deposits, bonds, debentures, mortgages, notes, annuity contracts, beneficial interests in an estate or trust, or patents. Income from real estate rentals is not always considered investment income (see section Income from Property or Business below).
If you hold investments in another country, in addition to reporting the income and paying tax in Canada, you may have foreign tax withheld from that income, or may be required to file a return and pay tax in that country. Some relief from this tax treaty.
Dividend Income
Taxation of Dividends
Dividends received by an individual from a Canadian corporation (public or private) are taxed at lower rates than ordinary income (business/employment income) to account for the fact that the corporation is paying the dividend out of after-tax corporate profits.
Any dividends received are “grossed-up” and included in income. The individual then receives a provincial and a federal dividend tax credit (“DTC”) tax deduction. Through the gross-up and DTC, the system recognizes the corporate taxes paid and it results in no element of double taxation.
Canadians also invest in public or private corporations that may not have access to the small business tax rates. The DTC is higher for dividend payments from income not eligible for the small business rate. These dividends are referred to as “eligible dividends”. Non-eligible dividends are dividends paid from the corporation’s retained earnings on income that was taxed at the lower small business tax rate.
In 2014, the federal grossed up the rate for non-eligible dividends to 18% (down from 25%). Also, the federal DTC rate became 11.017% of the grossed-up dividend (down from 13 1/3%).
In 2012, Ontario introduced a temporary 2% additional surtax (on income in excess of $500,000 a year (since 2014, this surtax has been applied to all incomes in excess of $220,000. The government has committed to eliminating the new surtax when the Ontario budget is balanced (expected to be in 2017-2018). The existing 56% Ontario surtax applies on top of the additional surtax.
Capital Dividends
Some dividends you receive from private corporations may be tax-free capital dividends. If the corporation has a balance in the capital dividend account (“CDA”), it can elect to pay a tax-free dividend. Generally, the CDA consists of the untaxed portion (currently one-half) of capital gains (net of capital losses), less any capital dividends paid in the past.
Stock Dividends
Public and private corporations can pay stock dividends by giving you new shares instead of a cash dividend. Even though you are not receiving any cash, the stock dividend is taxed as a regular cash dividend with the applicable gross up and dividend tax credit. The taxable amount of the dividend is based on your share of the increase in the corporation’s paid-up capital resulting from the new shares. This is usually substantially less than the full value of the stock dividend. You should receive a T5 information slip that will show the deemed amount and the taxable grossed up amount of the stock dividend.
Stock Split
A stock split is not taxable and should not appear on a T5 slip. A stock split occurs when a corporation increases the number of shares outstanding by issuing new shares in exchange for each share outstanding. You need to track these splits to determine the tax cost base of the shares you own.
If you are not sure whether you have received a stock dividend or stock split, you should contact the paying corporation or your broker.
Capital Gains Dividends
Capital gains dividends are distributions of capital gains by a mutual fund or investment corporation that are taxed as capital gains.
Interest Income
The same tax rates that apply to employment and business income apply to interest income.
When you invest with an institution such as a bank or trust company, you receive a T5 slip showing the interest to report in your income for the year. The T5 slip you receive includes interest earned and paid to you, plus interest earned but not yet paid to you if the investment pays interest less than once a year. You must pay tax on the annual interest earned on discount type investments such as “strip” or “zero coupon” bonds that do not actually pay interest annually.
Even if you do not receive a T5, as in the case of interest earned on loans to individuals, you are still required to report the interest income.
Real Estate Rental – Income And Losses
Income from Property or Business
Income from the rental of real estate (land, buildings and related assets such as furnishings) may be either income from property or income from a business. The distinction becomes important for calculating certain tax-related amounts such as:
- “Earned Income”, as it relates to the childcare expense deduction.
- Capital Cost Allowance (“CCA”).
- Cumulative Net Investment Losses (“CNIL”), which restrict access to the Capital Gains Exemption (“CGE”).
- Whether any income or loss transferred to a spouse or minor is deemed to be your own (see income splitting rules).
- The deductibility of certain expenses.
Rental Losses
Rental expenses are generally deductible in computing net rental income or losses only if the expenses are incurred for the purpose of earning income. Recent jurisprudence suggests that, provided there is no personal element to the rental operation, the rental operation will be considered commercial in nature and the expense will generally be considered incurred on account of earning income. CRA has proposed changes to the Income Tax Act, which would effectively require a taxpayer to establish an expectation of profit, over the expected duration of the particular source of rental income in order for the expenses to be deductible against the revenues from that source.
Business or Rental Use of Your Residence
If you rent out part of the house in which you live, you may deduct any expenses that relate specifically to the rented portion, subject to the discussion above. Those expenses that relate to the property as a whole (such as insurance and property taxes) must be apportioned between the rented part and the part used personally, normally on the basis of square footage or number of rooms. Due to the pending amendments to the Income Tax Act regarding the requirement for a reasonable expectation of profit, discussed above, you will normally be restricted from claiming any expenses in excess of your rental income, unless the rental use is more important than your personal use of the property. In such case, the property may not qualify for the principal residence exemption. If you have income after deducting the related expenses, you can claim CCA.
Other Investment Expense
Expenses such as legal fees, appraisal fees, survey costs and broker fees incurred with respect to the acquisition of an investment asset or property are generally not deductible. These items are added to the cost of the asset.
RRSP administration fees are not deductible if you pay them outside your RRSP. If you pay them inside your RRSP, these costs reduce the amount in your RRSP and consequently reduce the taxable income you receive out of your RRSP available upon retirement.
Investment expenses that are generally deductible include:
- Investment management fees.
- Fees for investment advice, where the advisor’s principal business is advising others whether to buy or sell specific shares, or whose principal business includes the administration or management of shares or securities.
- Fees for recording or accounting for investment income; and
- Bank charges, if the bank account is used solely to earn investment income.
Loss Deductions
Capital Losses
A capital loss can occur on the disposition of capital property as discussed earlier. An allowable capital loss (ACL) is defined as 1/2 of the capital loss. Under normal circumstances, the ACL is deductible only against capital gains realized in the year. An ACL is not deductible against other sources of income. An allowable capital loss can be carried back three taxation years and can be carried forward indefinitely to be deducted against capital gains.
Business Investment Losses
A business investment loss (BIL) is a unique type of a capital loss, which entitles the taxpayer to special relief in most circumstances. A BIL is a loss incurred in the sale of shares or debt in a qualified small business corporation.
An allowable business investment loss (ABIL) is defined as 1/2 of the BIL. The ABIL is deductible from any source of income in the year in which it is incurred. In arriving at the ABIL, there may be certain adjustments, such as a reduction by any CGE you have claimed in the past. Any excess of the ABIL over other income sources in the year can be carried back three years or carried forward ten years and deducted against income in those years. After ten years, any remaining ABIL converts into a regular allowable capital loss.
Non-Capital Losses
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If an individual incurs losses from a partnership or a business venture in excess of his/her other sources of income, the excess is a non-capital loss. Non-capital losses can be deducted against any income. Special limitations apply for taxpayers who are limited partners of limited partnerships. Non-capital losses arising in 2006 or subsequent years can be carried back three years and carried forward twenty years.
Tax Shelters
The use of tax shelters as an investment-planning tool has been declining in recent years due to various amendments to the Income Tax Act. Tax shelters are usually related to investments in the real estate, film, computer software, resource industries and “flips” to charities of art or shares. Tax shelters are usually promoted as an investment that entitles purchasers to substantial tax write-offs that will exceed the initial cash outflow. Due to the nature of the investment and CRA’s attitude towards most tax shelters, there is a high level of risk attached to these types of investments. For example, CRA has undertaken special projects to disallow tax savings on tax shelters. Income tax legislation has been revised to prevent what CRA considers overly aggressive tax planning.
Some tax shelters are set up as limited partnerships. The Income Tax Act limits the amount of the losses that can be claimed by a limited partner to the amount of capital that he/she has invested or placed “at risk.” The excess of the losses over the “at risk” amount can be carried forward and applied against future income from that limited partnership.