Income Tax and its Remedies
Personally taxing
Income tax is a direct tax levied on your income. Your income includes wages, salary, commission, benefits, and income from property and interest paid or payable during a given year. Income tax is not a tax on the increase in your wealth nor a tax on your consumption of wealth or capital.
Significant differences in tax treatment can result from undertaking identical income activities, generating the same before-tax cash flow, but through different legal organisational forms.
The major forms of organisation are:
• Individual, directly or through a sole proprietorship
• Corporation
• Trust, a legal form that separates legal and beneficial ownership
• Through a Partnership, a flow through form that flows income or gains through to its partners: corporations, natural persons, or even trusts
The remedies for income tax are varied. Three different types of remedy are available.
Incoming Shifting by type of income, for example, by legitimately changing income into capital gains
Income Shifting by taxpayer, for example shifting income from a taxpayer with a high marginal rate to lightly-taxed children or businesses with deductions or losses
Income Shifting by time, for example deferring the realization of income until retirement when one is, presumably, in a different tax bracket
Income Shifting – type
chasing the lowest rate
Income from wages, interest on bonds, and royalties are personal income in Canada, or ordinary income. Gains from the sale of shares and other capital assets are capital gains. Capital gains are generally taxed at 50% of the rate of ordinary income. Every taxpayer has a lifetimes capital gain exemption as well. Therefore, quite a lot of ingenuity has gone into shifting what could be ordinary income into capital gains. Some of the methods of doing so are unambiguous and unimpeachable, others are subject to re-characterization by the Revenue authorities.
There are numerous other ways in which the specific character of a receipt of income will have a major impact upon the tax rate. Effective tax strategy structures transactions to ensure that the character of the received income is in the most advantageous compliant form.
Money doesn’t grow on trees, but it can grow
Income Shifting – changing the pocket
Put it in your tax exempt
Increase in wealth or Income can be shifted from one person to another, or from one group to another. In the corporate world, often there are companies that have lost money who could retain on a tax free basis (because of their loss carry forwards) all of the funds earned by them. In the personal world, family members may have lower tax brackets, so shifting income can lower the rate of tax. Partnerships are effective vehicles available for either personal or corporate groups, that can shift income from the pocket of a highly taxed individual to a form that is exempt, or other entity that has tax pools.
Trusts are effective structures to put these type of arrangements in place. The provisions governing trusts in the Income Tax Act have many rules which attribute the income to one party or another. These rules can be utilized to effectively shift income from one taxpayer to another or to a tax exempt entity.
To discuss this type of income shifting email us here or fill in our contact form here. Or we’re available for a consultation toll free click to call here +1 833 CRA-FTAX or dial +1 833 272 3829 (833-CRAFTAX)
For further discussion on shifting income by type, we have outlined in our tax arbitrage page
Income Shifting – timing
pay it forward if at all
Some say time is a thief
Popular vehicles for tax shifting by deferral are the various Registered programs, such as RRSP. These defer income until such time as the taxpayer reaches retirement, or, in the case of an RESP, the children reach college age. There are two tax benefits: in the year of contribution and secondly any income earned inside the program is earned tax free, until withdrawal. Upon withdrawal income is taxed at the then going rate of income tax for the taxpayer in question. Since this is during retirement, the tax rate is less. These need no introduction to most taxpayers in Canada.
For extraordinary income, the most common method utilized by tax practitioners today to defer income is the straddle. To discuss this type of income shifting email us here or fill in our contact form here. Or we’re available for a consultation toll free click to call here +1 833 CRA-FTAX or dial +1 833 272 3829 (833-CRAFTAX)
But time isn’t a thief if you’re deferring your taxes