An Introduction to Canadian Tax | E007
Full Transcript:
Jason Pereira: Hello and thank you for joining me for The Wisdom of Wealth, a show where we help educate Canadians about fundamental financial literacy topics to help you make better and more informed decisions and to know when and where to reach out for help. I'm your host, Jason Pereira. Today, on Wisdom of Wealth, we're going to talk about something that we all have to deal with no matter how much we wish we didn't, tax. The old saying that "the only thing certain in life is death and taxes" is still very true, especially if you live in Canada. There are three general types of taxes around the world, taxes on income, taxes on consumption, and taxes on assets. In Canada, we have some form of all three and we're going to talk about each of them today. They can all add up.
Jason Pereira: In fact, the Fraser Institute estimates that the average Canadian household spends about 43% of their income on various forms of taxation for an average of $37,000 a year, making it the single biggest household expense. Understanding how taxes work and how to do some basic tax planning can help you be mindful of that bill. Let's get started with the biggest form of tax, income tax. Income tax is the primary form of tax Canadians pay. The concept is pretty simple. You make money and you pay a percentage of it in taxes. But the more you make, the more you pay. But that percentage is different based on your income. Canada employs what is known as a marginal or progressive tax system. This means that certain tax brackets apply to certain amounts. To explain this, let's look at a very simple example.
Jason Pereira: Let's say you make $75,000 in a year, and let's imagine that you have it all in your hand right now when the taxman comes. The first thing you'll have to do is put the money onto a table in smaller piles based on the amounts that the tax man tells you. They'll tell you to put the first $10,000 in the first pile, the next $20,000 in the second pile, next $30,000 in the third pile, and then the rest of it in the last one. Now, the tax man then comes along and looks at the first pile and says, "Okay. I'm going to take nothing from this, 0%." Then they come along to the second pile and they take 20% or $4,000, the third pile they'll take 30%, $9,000, and the fourth 40% from the last pile. The rate goes up as you move down the line. This is a concept known as tax brackets.
Jason Pereira: As you make more money, you reach what the government limits allow you to pay in tax on that amount of money, and then you have to start on the new pile. As you move down the line, the rates get bigger and bigger. This is how this applies to Canadians. No matter how much you make, all Canadians benefit from the lower tax brackets while higher income earners pay the higher tax brackets. The end result is that those who make more, pay more, and they do more at a faster and faster rate. Your last tax bracket is known as your marginal rate. This tells you how much tax you'll pay if you are in another dollar of income. In our example, the last rate was 40%, so that means if you earn another dollar, you're going to pay $.40 in tax. Now, in our example, the total tax bill was actually $19,000.
Jason Pereira: When you divide that by 75, you'll find that equals 25.33%. This is what is known as your average tax rate, what you actually pay as a total in tax. Let's stop and review this. The marginal tells you how much you pay on the next dollar, whereas the average tells you what it is you actually paid. Now, that was a simple example, but let's talk now about how tax rates actually look. Every province is different. In Ontario, the first 10,582 of income is tax free no matter how much you make. It doesn't matter if you're working part-time in McDonald's or if you're a professional athlete, you pay $0 on the first 10,582.
Jason Pereira: After that point, income starts becoming subject to tax and increases up the 12 different tax brackets in Ontario that start as low as 5.05% to a maximum of 53.53% on every dollar you earn over 220. Yes, there is a point that if you start making more than a certain amount, the government keeps more than what you keep. The story is similar across over half of Canadian provinces where tax rates exceed 50%. When people don't understand the difference between average and marginal tax rates, they sometimes fear that a raise will mean that all of their income is taxed at a new hire rate. That is never the case. You still benefit from lower tax brackets. It's just that the new money gets taxed at the higher rate. Now, let me cover basic forms of income tax.
Jason Pereira: Let's talk about other forms, specifically what happens when you invest in Canada. When you invest in Canada, you pay income tax on the returns and that depends on the form of return. Unless you hold that money in an RSP, TFSA, RESP or RDSP, all income is subject to tax. We're going to cover all those accounts in future episodes. To start, let's say that you buy something, a stock or a rental property, whatever it might be, and you sell it for a profit. This profit is what's known as a capital gain. Currently in Canada, capital gains are only half taxable. That means if you had $100,000 profit, only $50,000 will be added to your income. Another form of income is known as dividends. This is when you own shares in a company. Some companies will pay a portion of their profit to shareholders.
Jason Pereira: This is what's known as a dividend, as I mentioned. The tax rates on this are based on a bit of a formula. It's a little bit hard to grasp, but it does result in lower tax than regular income when this is from a Canadian company. If the company you own is publicly traded, that is to say that it trades on a stock exchange in Canada, then the maximum tax rate on these dividends is 39.34% versus the 53% that you're paying on normal income. If the company's private, the top rate is 47.4%. All other forms of income, whether it be interest, rental income or dividends from foreign companies, are taxed at your normal tax rate of 53%. Now, you're probably thinking that was a lot to take in. Even as simple as I made it, it's really complex when you really think about it.
Jason Pereira: These rates and brackets change, and they vary from time to time, and they vary from province to province. A qualified accountant and financial advisor can help you both understand the tax rates and how the tax system works and how to minimize your tax bill. Consumption taxes are charged on purchases of goods and services when you buy them. This is also known as a sales tax. In Canada, this tax takes the form of provincial sales tax, federal goods and services taxes, or when they're combined, the harmonized sales tax or HST. The math is pretty straightforward. You buy something, you take the sales price and multiply it by the tax rate. It doesn't matter how expensive the product is. The percentage never changes.
Jason Pereira: The percentage depends on the province you live in, and it ranges from as low as 5% in Alberta to as high as 15% in various provinces. Now, fair warning, in the last election, there were promises made about a luxury tax of 10% on big ticket items like boats and cars. If you're looking to buy a boat, you might want to move fast. Now, let's talk about the last form of tax, asset based taxes. There are various forms of asset based taxes around the world. These are basically a percentage charged on the value of something you own just because you own it. There's not many of these in Canada, but the most common one known is property tax. Everyone who owns a house knows about this. The amount is paid annually based on a percentage times the value or assessed value of your home.
Jason Pereira: Another form of this is probate. In some provinces, when you die, a nominal amount is charged based on the amount of the estate in the will. Depending on the province, this can be nothing, a flat fee, or a very low single digit percentage. In other countries, there are other forms of this type of tax, inheritance and state taxes, gift taxes, even wealth taxes on your entire net worth. Luckily, in Canada, we don't have any of these. Well, yet. Those are the three basic forms of taxes and how they work in Canada. Yes, it is definitely complicated. To help discuss what can be done to manage your tax burden and potentially lessen it, I've invited an accountant, Leanne LaRose of Kriens-LaRose, to join me in the studio today.
Jason Pereira: Today in the studio we have Leanne LaRose of Kriens-LaRose. Leanne, thank you for joining us.
Leanne LaRose: Thanks, Jason, for having me.
Jason Pereira: My pleasure. Leanne, tell us what it is you do.
Leanne LaRose: Well, I'm an accountant and I usually practice tax. I work with owner-managed businesses, self- employed people, commission agents, various-
Jason Pereira: You take care of the scary tax form.
Leanne LaRose: Yeah.
Jason Pereira: Yeah, exactly.
Leanne LaRose: Hopefully.
Jason Pereira: Hopefully. Okay. First off, let's talk about people's responsibilities around taxation. Now, it's on the individual to know that they have to file and they have to file by certain deadlines. What do they have to do to be in line with government regulations?
Leanne LaRose: The filing deadline is April 30th.
Jason Pereira: It's coming it.
Leanne LaRose: It's coming up, yes. One of the common miscommunications I find with self-employed people is they do have a filing obligation that is extended to June 15th. However, the tax is still due by April 30th.
Jason Pereira: Yeah. You got to pay it.
Leanne LaRose: You've got to pay it and a lot of times you need to figure it out before you know. I encourage my clients to come in for April 30th because if you've got to pay the tax, you might as well determine how much that is.
Jason Pereira: It seems backwards, right? You basically tell the government how much you owe or you think you owe after you've actually paid it, which is quite amusing. Pretty straightforward. I'm sure that you have encountered on countless occasions clients coming in with all their paperwork and saying, "Okay, here's my stuff. Make me pay no tax. Work your voodoo magic," and that's just not possible, right?
Leanne LaRose: It's not possible, especially if they are an employee. There's not much we can do. There's not a lot of tax planning involved. It actually can't be done at that time. As you know, Jason, the best tax deduction would be your RSP. If you haven't done that by February 29th, then you're probably not-
Jason Pereira: In a leap year.
Leanne LaRose: In the leap year, which is this year.
Jason Pereira: Yeah. Besides the reality is is that we're being taxed on the previous years, so the RSP is different because it allows us to do something in the current year. But if you haven't done it in the previous year, it doesn't count, right? Once people have come in and you've explained that you're not a wizard and you
can't make their tax situation disappear and you want to educate them as to how they can minimize their taxes going forward, what types of solutions exist?
Leanne LaRose: Well, I ask a lot of questions, so I get to know my client to what their situation looks like because sometimes they don't know what they don't know.
Jason Pereira: Exactly.
Leanne LaRose: Whereas I do. I concentrate on tax credits versus deductions because there's very little deductions out there these days.
Jason Pereira: Let's talk about the difference between those two.
Leanne LaRose: Okay.
Jason Pereira: Deductions, what's a deduction?
Leanne LaRose: A deduction is something... A legitimate tax deduction that we take against our gross income. Therefore, actually when you were talking about marginal rates, that deduction occurs at whatever your top marginal rate is that you are preparing your tax.
Jason Pereira: I made 100,000 the previous year. I have a deduction for 10,000, so now I'm really making 90.
Leanne LaRose: Exactly.
Jason Pereira: But they collected a hundred, so I basically... If my tax rate is 40, 10 times 40, $4,000 in taxes.
Leanne LaRose: Exactly.
Jason Pereira: Okay.
Leanne LaRose: Whereas a tax credit is usually a credit in most cases at the lowest tax bracket. Medical expenses, for example. There's a couple contingencies on that, which I can get to when we talk more in depth on medical expenses, but that would be a tax credit more at like the 29% tax rate, which is your minimum.
Jason Pereira: You spend $1,000 on medical expenses, right? People often think that a tax credit means that they don't pay that in tax, right?
Leanne LaRose: Mm-hmm (affirmative). Yes.
Jason Pereira: Unfortunately, I have broken many people's hearts by saying, "Sorry, that's not how it works," right?
Leanne LaRose: Right.
Jason Pereira: That tax credit is applied to a certain rate, usually the bottom rate, 15% federally, and you save on that thousand dollars up to $150, right? You're at least saving tax, but it's not wiping out the same amount, right? People get confused by that. I spent this. Why am I paying that? Well, it's not one for one. There's not many deductions. Tell us what deductions do exist.
Leanne LaRose: For the average person that has employment income and a young family, husband and wife both working, they have childcare expenses. The limit for childcare expenses... Yes, you probably paid 25,000 or 30,000 for your daycare or your nanny, but it's not all a deduction. The maximum deduction would be $5,000 for children under the age of six, assuming that they're not at full-time school, and then... I mean, sorry, $7,000 for children under six and $5,000 for children over the age of six.
Jason Pereira: There's a limit on how much you can do.
Leanne LaRose: There's a limit on how much you can do, but it is a deduction. The other caveat is it's a deduction by the lower income spouse unless and then there's some caveats as to when the higher income spouse can actually claim that deduction. Other deductions such as professional dues to-
Jason Pereira: Like union dues?
Leanne LaRose: Union dues or dues for your profession that you need to maintain in order to continue to act in your profession.
Jason Pereira: Like a lawyer or accountant?
Leanne LaRose: Yes, if your employer doesn't pay them on your behalf, and investment management fees. If you have a portfolio where you require an investment advisor to manage that portfolio and you're paying a fee on that and you earn investment income, you would be able to-
Jason Pereira: Only on non-RSP, TFSA.
Leanne LaRose: Exactly.
Jason Pereira: It's got to be taxable.
Leanne LaRose: Not the registered accounts.
Jason Pereira: Okay.
Leanne LaRose: Certain legal fees for certain reasons would be-
Jason Pereira: But not fighting traffic tickets, right?
Leanne LaRose: No, definitely not.
Jason Pereira: That's deductions. Now, let's talk about credits. What sort of credits exist out there?
Leanne LaRose: Well, we all have our personal credit, which you mentioned in your-
Jason Pereira: The 10,000 change.
Leanne LaRose: The 10,000 provincially, 12,000 in change federally. There is an age credit for people over the age of 65. However, as your income increases, it's taken away. There are disability tax credits for oneself or for a dependent that you have, the dependent under the age of 18 that has no income. You get tax credits.
Jason Pereira: This is an important one.
Leanne LaRose: Very important, but it's very complicated.
Jason Pereira: It is complicated, but also very underused. We're going to have an episode about this specifically in the future, but it's anyone who's got any kind of ongoing care for some sort of disability really needs to look to file for one of these.
Leanne LaRose: Interesting, there's deductions and credits and medical expenses that can actually be used and claimed for all for that dependent child in many different ways. I can give you an example of where you could claim a deduction for a disabled child, for example, that's under the age of 18 where you have a live in caregiver, for example, and you're paying that caregiver maybe $50,000 a year to manage and help you with your disabled child. You would get your $10,000 child care deduction, because it increases to 10,000 for a disabled child, and then you still paid 40 or 50, you might be able to claim a medical expense for the difference because there is a reason why you need that caregiver.
Jason Pereira: It sounds complicated.
Leanne LaRose: It's complicated.
Jason Pereira: This is why, again, professionals get paid for what they do because you're going to have to sit down with your clients, like you said, like understand them, ask all kinds of questions because the things that they're doing in their day to day life, some of them they think are appropriate for taxes or applicable to taxes and others, they just don't even stop to think that they apply, right?
Leanne LaRose: Exactly.
Jason Pereira: The most lucrative tax credit, which is one that we plan around a lot, is the charitable tax credit. How much do we save on making a charitable donation?
Leanne LaRose: Well, interesting, we talked about credits being at the lowest bracket. There's been a massive surge obviously to encourage people to donate. Actually the more you donate, you can go up to the highest credit or one of the highest credits, up to 40% or so.
Jason Pereira: Yeah. I basically gave $1,000 to charity. I can save $400 in tax.
Leanne LaRose: $400. There's also an amazing double dip we say where if you actually donated shares in kind, for instance, if you have shares-
Jason Pereira: I buy something at 100 bucks, you said 150 is a gain there?
Leanne LaRose: There's a gain you can avoid.
Jason Pereira: I would pay tax, but I can avoid the gain now because-
Leanne LaRose: You avoid the gain if you donate the stock. You'll get a donation receipt for the fair market value of that stock, and you don't have to report the capital gains. It's actually a double benefit if you wanted to donate stocks with accumulated gains.
Jason Pereira: It's funny because people often ask me like, "Oh, I've got this big capital gain. How do I not pay tax on it?" Give it away.
Leanne LaRose: Give it away and then you'll get a tax credit.
Jason Pereira: There's no answer. You can't get away from it. That's the big one. Now, those are deductions and credits. Let's talk about responsibilities beyond what we talked about. For example, what happens if you own property in a foreign country or basically a rental property or just another home?
Leanne LaRose: Okay. We have foreign property reporting rules reported on a separate form, and it has definite reporting deadlines. One of the things I always tell my clients, even if you think you're getting a refund so you're not going to file by April 30th, if you actually have foreign property, make sure you file it on time because elections have penalties for not filing on time, even though there's no tax implications.
Jason Pereira: What are those penalties?
Leanne LaRose: Off the top of my head, I don't know. It could be up to $10,000 for a late filed foreign property.
Jason Pereira: Wow.
Leanne LaRose: It's quite significant. I think I've seen some at 2,000. Depending on the length or time, it might be $100 a day or $100 a month. Sorry, I don't have that off the top of my mind.
Jason Pereira: Still it's pretty significant.
Leanne LaRose: It's important. The key thing is it's foreign property. A lot of people think, "Oh, I don't have anything outside of the country." Foreign property in excess of $100,000 cost base in Canadian dollars. Foreign property includes shares in trading on a foreign exchange that you're holding with your Canadian broker.
Jason Pereira: I bought Apple or Microsoft and I paid 60 some odd thousand Canadian for... Sorry. Yeah, so I pay 100,000 Canadian or 60 some odd thousand US. I think it's 60,000 US, but really it's over 100,000 Canadian. I got to report that.
Leanne LaRose: You've got to report. Now, it's not a tax obligation. It's just a reporting obligation, but it's really important that you understand that. If you are just investing with a Canadian broker, they know how to produce the reports. We have to be conscious. It's one of our questions we ask our clients as we get to know them. Interesting you asked about a difference between a rental property, a foreign rental property, and a foreign home. Now, if you have a foreign property but you use it personally, you do not rent it out, so you have that condo in Florida, whatever, that's not foreign reportable property because you're not renting it.
Jason Pereira: It's not an investment.
Leanne LaRose: It's not an investment. But if you actually use it personally and rent it, then you are triggering foreign property reporting.
Jason Pereira: Let's talk about that. Let's debunk a myth out there. People hear the term "off shore" all the time, right, and they assume that there's this magical way that you can not pay taxes if your assets are outside the country. What's the reality of the situation?
Leanne LaRose: The reality is you pay tax in Canada on your worldwide income. In Canada, we pay tax based on residency. If you're a resident of Canada, you pay tax on your worldwide income. Therefore, if you have an income-
Jason Pereira: If you're not doing that, if you're not reporting taxes-
Leanne LaRose: If you're not reporting the income that you're earning on your UK bank account or whatever, you really should. You might consider a voluntary disclosure to look at whether you should have gotten reporting.
Jason Pereira: Anything that you forgot about doing, yeah. You forgot about doing. Here's the thing I will tell people like, "Oh, how are they going to find out?" They are getting really good at finding out. Countries are sharing information front and center now because it's not one country who's got a problem with only their citizens doing it in their country. People are basically hiding money or having money outside of their country. The UK may have residents who have assets in the US and they're not declaring them in the UK, right? That's not a tax haven, but the UK wants to know about that, right? The Americans retrospectively want to know about the Americans in the UK, so they're swapping data. This is not a smart move to make going forward.
Leanne LaRose: Right. A lot of times it's really just not knowing the rules. It's not because somebody doesn't want to report. They don't understand what they have to-
Jason Pereira: Well, they rented it out for two weeks. They didn't even think of it, right? It's small. There's one unique situation though based on where you were born and that's if you're an American citizen or an American taxpayer. There's a different set of obligations. What are those obligations?
Leanne LaRose: If you are an American citizen living in Canada and working in Canada, you still have an... Now, the US tax is based on citizenship, not on residency. Irrelevant of whether you're a resident of the US, you still are obligated to file.
Jason Pereira: It doesn't matter where I live. I could live in Canada. I could live in Zimbabwe. It doesn't matter. I'm always reporting to the US.
Leanne LaRose: You have to file. A US person is defined by US citizen, a US green card holder.
Jason Pereira: Possibly children of American citizens sometimes.
Leanne LaRose: You do have to make sure... I mean, all of those filing obligations might be outside of the realm of this, but just be aware. If you are a US person, you do have obligatory filing obligations in the US.
Jason Pereira: I'm an American citizen living in Canada. I have to file in the US and Canada at the same time. I mean [inaudible 00:22:36]
Leanne LaRose: Nine times out of 10 you don't actually owe tax in the US, right? Canada has a higher tax rate than the US. There's no such thing as double taxation. If you've paid your tax in Canada, the likelihood of you owing tax in the US is very, very small. The difference would happen maybe we pay tax on only half our capital gains.
Jason Pereira: There's some differences.
Leanne LaRose: There might be some differences, but it's rare.
Jason Pereira: Let's go back to double taxation. If for whatever reason I'm in another country or my assets are in another country and I pay tax on that income and then I have to declare that income in Canada, what happens?
Leanne LaRose: If you've filed a foreign return to report that specific income, the tax that you paid on that tax return we would, nine times out of 10 under the treaties, be able to take a tax credit in Canada on taxes paid outside of the country. You're only paying the differential. If Canada is a higher taxed country, you'll pay the differential. If Canada's a lower tax country, you're not getting any more tax back in Canada, you just don't have to pay an additional tax on that.
Jason Pereira: As a simple example, let's say that I earned $5,000 in a foreign jurisdiction and in Canada I want to file my tax returns. All my worldwide income equals $20,000 in income. Well, basically I wouldn't pay 25,000, right? I would pay 15 in Canada, five in the foreign jurisdiction for a total of 20. If for whatever reason the tax rate is higher in the foreign country, then Canada's not going to turn around and tax me at the higher amount. They're just going to, again, offset whatever I paid here.
Leanne LaRose: Yeah.
Jason Pereira: Yeah, good. People are often scared about that saying, "Why am I paying there and here? I'm getting screwed." The term screwed gets used a lot when it comes to taxation, but essentially that's not the case.
Leanne LaRose: They try to be.
Jason Pereira: They try.
Leanne LaRose: Try to make sure that we don't have double taxation in many cases.
Jason Pereira: Before we wrap up, what are some just basic tips on how people should deal with their filing obligations and what they can do in advance of the year end to basically maybe make sure they're in order or minimize their tax bill?
Leanne LaRose: I know we talked about credits. There's a couple other credits that a lot of people ask about and that would be their children's tuition. You have kids in university and you want to file their tax return because you need to report their university and their tuition on their return. If the child agrees, they can transfer some of the tuition credits to a parent if they don't need them. They can transfer up to a maximum of $5,000 of the tuition. The balance, if the child doesn't use those credits, in fact, the child will use them in the future and they can carry them forward. A lot of times the kid says, "Oh, I don't know any tax. I'm not going to file a tax return." We really encourage-
Jason Pereira: Mom and dad owe tax. It's time to give them a break.
Leanne LaRose: We encourage the kids to file the return so they can accumulate their tax deferral in the future. They can get their GST rebates and their Trillium credits if they actually are paying rent at the university.
Jason Pereira: There's actual benefits coming back to them.
Leanne LaRose: Of course, as you can appreciate, if they've made $5,000 at their part time job in the summer, they're accumulating RSP contribution room to use in the future. Their kids that are in university over the age of 18 that don't owe tax should still file their tax returns.
Jason Pereira: Well, it's funny you mentioned that. I hear this all the time a lot, "I haven't filed my tax return, but I don't owe anything. It's fine." Well, if you don't owe anything, odds are the government owes you money and you're just giving them an interest free loan until you decide to actually get your paperwork.
Leanne LaRose: In fact, they're being more strict on statute barred return. If you haven't filed for 10 years and you have refunds, they're going to stop. They might not-
Jason Pereira: You might lose your refunds.
Leanne LaRose: ...give you your refund back 10 years or whatever. Statute barred might say, "Listen, I'm sorry. You're negligent. I'm not giving you your refund." File and get your refund.
Jason Pereira: This loan has become a permanent donation.
Leanne LaRose: Exactly.
Jason Pereira: Oh wow. With no tax deduction for it. Lovely. Great. Make sure you're aware of the credits. I think basically talk to a professional.
Leanne LaRose: Yeah. File your tax return. It's not as scary as everybody worries about, and I think it'll give you more... It lets you sleep easier at night knowing that it's filed versus worrying about it and accumulating the stress of not filing.