Since the government removed automatic indexing to certain deductions and credits, we have all experienced a hidden tax resulting from inflation. Fortunately for us, this has happened at a time when the inflation experience has been low. The basic exemption will rise to $6,794 in 1999 and $7,131 in 2000 and the spousal/equivalent-to-married exemption will rise to $5,718 in 1999 and $6,055 in 2000.
CHILD TAX BENEFIT
The income threshold will increase from the present $25,921 to $29,590. This will qualify more people for the monthly benefit.
DEATH AND TAXES
Presently, RRSP/RRIFs are taxed in the year of death, unless there is a surviving spouse, in which case the funds can transfer tax-free to the survivor. Where there is no surviving spouse, the funds may go to a surviving dependent child or grandchild. commencing in 1999, the latter treatment will be permitted regardless of there being a surviving spouse.
The 1986 temporary surtax was lifted last year for those with incomes under $65,000. Effective, July 1, 1999 it will be removed for everyone.
In the past, we have had income-averaging, forward-averaging and general-averaging provisions which spread the taxation of income, in certain situations, across multiple tax years, in order to provide a lower tax burden. The last of those came to a close in 1997.
The Budget adds a provision which, surprisingly, will apply retroactively to 1995. Severance receipts, superannuation or pension benefits, spousal or child support and E.I. benefits in excess of $3,000 which relate to a prior year or years will qualify for this new “special mechanism”.
Taxpayers can request Revenue Canada to determine whether they are better off under the existing system or this special mechanism which notionally recalculates your taxes over all of the historical years involved. To sour the pot, “real” interest will be added to these notional back calculations before it is determined whether you are better off or not. The changes will not affect entitlements previously received that were income-tested, like GST credits.
This is reminiscent of a change made last year related to the Alternate Minimum Tax, which also had retroactivity. In the ensuing year, we have not seen any actions initiated by RevCan to trigger refunds! While averaging provisions are fair and useful to taxpayers, it isn’t apparent that this was the most glaring wrong that needed to be fixed!
THE IMPORTANCE OF BEING HONEST
Canadian tax law includes both criminal and civil penalties that may apply to misrepresentations of tax matters. Presently, there are criminal penalties where a person participates in tax evasion in respect of their own or another’s taxes. There are also civil penalties where a person knowingly made false statements in filing their own tax returns. This budget adds civil penalties to third parties who knowingly make false statements in respect of another’s tax returns.
This applies firstly to people who knowingly promote tax planning arrangements (read “tax shelters”) which they know are outside the law. Secondly, this applies to people who assist in filing returns, forms, certificates or representations to Revenue Canada which they know are outside the law. The penalties are harsh, starting at $1,000 or one-half of the tax avoided.
FAMILY TRUSTS BROAD-SIDED
If you have stood behind someone at a check out counter and watched them pull out a cheque book to pay $6.00 for children’s socks, odds are you just saw a family trust in action. Many tax practitioners have helped their clients to form these trusts, particularly to fund private school tuition. These arrangements were frequently used by self -employed professionals of all types: accountants, lawyers and health professionals.
Under the plan, a trust would be created which would receive a special class of shares in the parent’s operating business. Annually, the operating company would declare dividends to the trust which, typically, had been taxed at only 22% at that point. Coincident with this, dividends would be paid out from the trust to the children. The magic amount of approx $23,000 per child would not incur any further personal tax to the children due to the dividend tax credit and the low 26% tax bracket. Until a few years ago, the funds needn’t even leave the trust; all of this was done “on paper” under the “preferred beneficiary” election.
In many cases, the catch was that, typically, the parent wasn’t able to part with, say, $46,000 annually for two children, so a way had to be found to close the circle and return the funds to the parent to pay the family bills. Thus, the parent would make sure that a broad range of expenses related to the child were paid directly from the trust and other expenses were charged to the trust by the parent.
I have predicted for a long time, and as recently as last summer, that this plan would see the taxman’s skewer … and it has!
Commencing in 2000, such dividend payments to a child under age 18 will be subject to a special tax at the highest marginal rate. This income will be taxed separately from any other income the child may have, and the various personal exemptions will not apply against this income. The only thing that will apply against this income is dividend or foreign tax credits. Also, the provision extends joint liability for the resulting tax beyond the child to the parent.
No doubt, these changes will curtail the formation of many new family trusts and, equally, cause existing ones to rest dormant.