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24.2.4 Taxation Of Income From Property

Learn about the taxation of income from property including registered plans, interest income, dividends from taxable Canadian corporations, and dividends from foreign corporations. Discover the intricacies of capital gains, and methods to minimize taxable investment income.

Income From Property

Except for property consisting of investments held in a registered plan, income from property is taxable in the year it is earned. The tax must be paid on an annual accrual basis, regardless of whether it is actually received as cash in that year.

Key Points

  • Income from property outside a registered plan is taxed on an accrual basis, meaning it must be reported when it is earned, not when it is received.
  • For zero-coupon bonds and similar investments, tax is charged annually even though income is received at maturity or sale.

Did You Know?

Income from property held outside a registered plan is taxed on an accrual basis. In other words, it must be reported for tax purposes when it is earned, not when it is received. For example, the income of products like zero-coupon bonds are received only at maturity or at sale, but the tax on such investments is charged annually. As an investment advisor, you must be cautious about taxes due on amounts not yet received.

Interest Income

Interest income is the compensation received by lenders for the use of the funds they lend. This type of income is fully taxable at the investor’s marginal tax rate, either when it is received or as it accrues. Accrued interest is included in taxable income every year and can be deferred for no more than one year.

Definitions

  • Accrued Interest: Interest that has been earned but not yet received.
  • Marginal Tax Rate: The rate at which the highest dollar of income is taxed.

Dividends from Taxable Canadian Corporations

A breakdown of taxes and benefits of dividends from Canadian corporations

Types of Dividend Tax Credits

Two types of dividend tax credits are available: one for privately-held and another for publicly-traded corporations. Here, we focus on tax credits available on publicly-traded corporate shares.

Understanding Dividend Tax Credit

The dividend tax credit makes the purchase of Canadian shares attractive compared to interest-paying securities as this credit offsets the amount of tax the corporation paid.

In 2020,

  • Eligible Canadian dividends are grossed-up by 38% to arrive at the taxable amount.
  • The taxpayer receives a federal dividend tax credit amounting to 15.02% of the taxable amount.

For example,

Sandra receives a $1,000 eligible dividend from a Canadian corporation. She reports a net income of $1,380 for tax purposes.

Calculation:

(A) Eligible Canadian dividends: $1,000

(B) Gross-up total amount (38%): $380

(C) Taxable amount of the dividend (A + B): $1,380

Sandra claims a federal dividend tax credit (15.02%) on $1,380: $207.28

The actual tax payable depends on Sandra’s marginal tax rate.

Example Breakdown: Sandra’s Marginal Tax Rate

Taxable Amount ($1,380) 15% Tax Rate 20.50% Tax Rate 26% Tax Rate 29% Tax Rate 33% Tax Rate
Federal Tax Amount $207.00 $282.90 $358.80 $400.20 $455.40
Minus Tax Credit $207.28 $207.28 $207.28 $207.28 $207.28
Net Tax Payable $0.00 $75.62 $151.52 $192.92 $248.12

T5 Tax Form

Shareholders receive the T5 form to identify investment income for tax purposes. The issuing entity depends on how shares are held—either by the corporation or by an investment dealer.

Did You Know?

A T5 tax form is a document identifying the investment income that Canadian residents must report on their income tax returns.

Foreign Dividends

Foreign dividends are taxed as regular income, subject to foreign non-resident withholding taxes, and may allow the use of foreign tax credits to offset collected Canadian income tax.

Foreign Tax Credit Criteria

  • The allowable credit is the lesser of the foreign tax paid or the Canadian tax payable on the foreign income.

Capital Gains and Losses

Capital gain arises when property is sold for more than its cost, while a capital loss occurs when property is sold for less than its cost. Capital gains are represented favourably as only 50% of the gain is taxable.

Did You Know?

  • Capital Gains: Realized profit from a sale priced higher than when property was acquired.
  • Capital Loss: Realized loss from a sale priced lower than when property was acquired.

Tax Simplification

Capital losses can reduce capital gains but typically cannot reduce other types of income.

Minimizing Taxable Investment Income

Shifting investments to dividend-paying Canadian stocks or on capital gains might minimize overall taxation compared to earning purely from interest-bearing investments.

Comparison Thereof

Below, tables illustrate tax difference on $1,000 of varied incomes at different tax rates to highlight tax implications:

Type of Income Age Thresholds: 29% Rate
Interest Income $290
Eligible Canadian Dividend $192.92
Capital Gain $145

Frequently Asked Questions (FAQs)

Q1: When is property income taxed?

  • Property income is generally taxed in the year it is earned on an annual accrual basis, even if the income is not received as cash until a later date.

Q2: What is a dividend tax credit?

  • A dividend tax credit offsets the amount of tax paid by the corporation, applied to dividends received from Canadian corporations.

Q3: How do foreign dividends get taxed?

  • Foreign dividends are taxed as regular income, which may involve foreign non-resident withholding taxes, and can sometimes be offset by foreign tax credits under Canadian taxation laws.

Glossary

  • Accrued Interest: Interest that has accrued over a period but not yet received.
  • Marginal Tax Rate: Tax rate applied to the next dollar of taxable income.
  • Dividend Tax Credit: A tax credit given to mitigate double taxation on dividends.
  • Gross-Up: Increasing the amount of dividend income to reflect pre-tax income of a corporation.
  • Capital Gain: Profit from the sale of property/investment.
  • Capital Loss: Loss incurred from selling property/investment below its purchase cost.
  • T5 Tax Form: Form used to report investment income.

Key Takeaways

  • Income from property is generally taxed annually on an accrual basis.
  • Different types of investment income (interest, dividends, capital gains) have varied tax implications.
  • Proper tax planning and strategic shifting towards certain investment vehicles can minimize overall tax liabilities.
  • Dividend credits, tax forms, and capital gain treatments are essential to understand for effective investment advising and compliance.

By understanding the taxation rules surrounding income from property, advisors can better guide their clients in making tax-efficient investment decisions.


CSC® Exams Practice Questions

📚✨ CSC Exam Questions ✨📚

Welcome to the Knowledge Checkpoint! You'll find 10 carefully curated CSC exam practice questions designed to reinforce the key concepts covered. These questions will help you gauge your grasp of the material, identify areas that need further review, and ensure you're on the right track towards mastering the content for the Canadian Securities certification exams. Take your time, think critically, and use these quizzes as a tool to enhance your learning journey. 📘✨

Good luck!

### Quiz 1 ## When is income from property held outside registered plans taxable? - [ ] When it is received as cash - [x] When it is earned - [ ] Upon sale of the investment - [ ] Never > **Explanation:** Income from property held outside registered plans is taxed on an accrual basis, meaning it must be reported for tax purposes when it is earned, not when it is received. ### Quiz 2 ## How is interest income taxed? - [x] At the investor’s marginal tax rate - [ ] At a flat rate of 10% - [ ] It is tax-exempt - [ ] It is deferred until sale > **Explanation:** Interest income is fully taxable at the investor’s marginal tax rate, either when it is received or as it accrues. ### Quiz 3 ## What is the gross-up percentage for eligible Canadian dividends in 2020? - [ ] 25% - [ ] 50% - [ ] 100% - [x] 38% > **Explanation:** Eligible Canadian dividends are grossed-up by 38% in 2020 to arrive at the taxable amount of the dividend. ### Quiz 4 ## What is the purpose of the dividend tax credit? - [ ] To provide a tax refund - [ ] To tax dividends at a higher rate - [x] To offset the tax paid by the corporation - [ ] To eliminate taxation on dividends altogether > **Explanation:** The dividend tax credit reflects the fact that corporations pay dividends from after-tax income. It offsets the amount of tax the corporation has paid, making the purchase of these securities relatively attractive. ### Quiz 5 ## How are foreign dividends generally taxed? - [ ] As non-taxable income - [x] As regular income - [ ] Only after netting out capital gains - [ ] They are exempt if below $1000 > **Explanation:** Foreign dividends are generally taxed as regular income, similar to the way interest income is taxed. ### Quiz 6 ## How much of a capital gain is taxable in Canada? - [ ] 100% - [ ] 75% - [ ] 25% - [x] 50% > **Explanation:** In Canada, only 50% of the capital gain is taxable. ### Quiz 7 ## What is the main tax difference between interest income and eligible Canadian dividend income? - [ ] Only dividends are taxable - [ ] Interest income is grossed-up, not dividends - [x] Dividends receive a tax credit, interest does not - [ ] There is no tax difference > **Explanation:** Dividends receive a tax credit because they are paid from after-tax income by corporations, whereas interest income does not receive such a credit. ### Quiz 8 ## Sandra receives a $1,000 eligible dividend from a Canadian corporation. What is her net dividend income for tax purposes? - [ ] $1,100 - [ ] $1,200 - [x] $1,380 - [ ] $500 > **Explanation:** Sandra reports $1,380 in net income for tax purposes because the $1,000 eligible dividend is grossed-up by 38% to arrive at the taxable amount. ### Quiz 9 ## What form is used to report dividends for tax purposes in Canada? - [ ] T1 - [ ] T2 - [x] T5 - [ ] T4 > **Explanation:** A T5 tax form is used to report the investment income that Canadian residents must include in their income tax returns. ### Quiz 10 ## What is the federal dividend tax credit percentage on the taxable amount of eligible Canadian dividends in 2020? - [ ] 10.50% - [ ] 18.15% - [ ] 20.00% - [x] 15.02% > **Explanation:** The federal dividend tax credit on the taxable amount of eligible Canadian dividends is 15.02% in 2020.

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Sunday, July 21, 2024