In a recent article, we described the changes to income tax rates that the provincial government has enacted and the increase to income tax rates that the incoming federal government has pledged to enact. Due to the magnitude of the tax rate increases, it is evident that there are tax savings that can be realized if income is received in 2015 rather than in 2016, particularly for individuals earning more than CA$200,000 per year, as the top marginal individual income tax rates are increasing for all types of income in Alberta. Below, we discuss some tax planning opportunities available to accelerate taxable receipts into 2015 and other planning considerations. To ensure they meet their objectives, high-earning Albertans should consult their tax advisor as soon as possible to determine whether the cost/benefit of accelerating taxable receipts into 2015 is appropriate to minimize the impact of these tax rate changes, or if alternate planning would be more suitable.
Acceleration of income
Salaries and bonuses
Owner-managers can increase their income in 2015 by increasing salaries, bonuses or dividends received from their corporation. In 2015, it is more effective to increase salaries or bonuses rather than receiving corporate distributions as dividends because the top marginal rate on salaries and bonuses is less than the top marginal rate on eligible and ordinary dividend income. Assuming the tax rate changes are enacted as proposed, in 2016, it will be more tax effective for owner-managers to receive salaries, bonuses or ordinary dividends than eligible dividends. The rate changes are not certain, however, as the Alberta government pledged in the 2015 Budget to review and/or amend the effective tax rates on dividend income in 2016. Until these details are finalized, it will not be certain whether salaries, bonuses and ordinary dividends are more tax-effective than eligible dividends in 2016.
An increase in salaries and bonuses in 2015, combined with the changes to tax rates for high-earning Albertans in 2015 and future years, will increase the source deductions required to be withheld and remitted to the Receiver General for Canada. Employers should be diligent to confirm that they are withholding and remitting the correct amount of employee income tax source, EI and CPP deductions. This is of particular concern to owner-managers, as corporate directors can be held personally liable for the failure to withhold and remit source deductions.
ESOP and stock option considerations
To assist employees with repaying bank debt used to acquire stock pursuant to a stock option plan, some employers have been returning capital to employees rather than paying taxable dividends to them. Due to the changing tax rates it may be preferable to pay two years' worth of dividends in 2015, and then to return capital in 2017 and subsequent years. Likewise, high-earning employees who own stock options in taxable Canadian corporations that are not Canadian-controlled private corporations (CCPCs)—for example, publicly-traded corporations—should consider exercising vested options in 2015 in order to move the income inclusion into 2015. The incoming federal government has also pledged to cap the stock option deduction at CA$100,000, which may give further cause to exercise vested options in 2015.
Share redemptions and buy-backs
High-earning Albertans who have share redemptions or buy-backs contemplated in the near future should consider whether to accelerate the redemption/buy-back program into 2015. Further, even if no redemption or buy-back plan is in place, consideration could be given to redeeming or repurchasing shares in 2015, and then using the after-tax amount to re-subscribe for shares in the corporation. These new shares will now have a high cost base and paid-up capital, and can be bought-back or redeemed in later years with little to no tax consequences.
Acceleration of capital gains
Transfers and sales
The top marginal rate on capital gains in Alberta is set to increase in 2016 from 20.13% to 24.00% (an increase of almost 20%). If significant events, such as the sale of a business, are contemplated in 2016 or later years, high-earning Albertans should consider whether the sale can be moved into 2015 in order to minimize the effect of these tax rate changes.1 This reasoning would also apply to high-earning Albertans who are likely to be deemed to dispose of capital property in the near future, such as terminally ill individuals, who could direct the transfer of their property to occur in 2015 and trigger the disposition prior to death. Further, taxpayers should review personal investment portfolios and other property that may have an accrued gain to determine whether realizing a gain on a transfer in 2015 is feasible.
Any steps to transfer property in 2015 to minimize the effect of changing tax rates should be taken in short order to give your legal counsel and tax advisors adequate time to perform the requisite due diligence critical to properly carrying out the transaction.
An internal reorganization of corporation shares could also be carried out in 2015 to trigger capital gains and prepay tax in 2015. This could take the form of an internal share exchange, where a capital gain is triggered in the hands of the individual and increases the cost base of the new shares held by the shareholder, reducing a gain in a subsequent year when the shares are disposed of. The relevant underlying corporate documents, such as the Articles of Incorporation (the Articles), or a shareholder's agreement, should be reviewed to ensure that the proper share structure and authorizations are in place prior to the effective date of the transaction. Should an amendment to the Articles of a corporation or shareholder consents be required to authorize the reorganization, your legal advisor will need the time to implement the amendment and obtain any required consents.
Earned Income – RRSP
High-earning Albertans could postpone claiming their RRSP deduction until 2016 to take advantage of the deduction against the higher tax rates in 2016 and beyond.
Capital reserves, capital gains exemption, use of capital losses
High-earning Albertans should consider avoiding the use of capital reserves, their capital gains deduction or the use of capital losses in 2015 to take advantage of the changing tax rates, by accelerating income or gains into 2015 and moving applicable reserves, exemptions and losses into 2016 and beyond, when tax rates are higher and the applicable deduction or exemption has more impact.
Other discretionary deductions or credits
CCPCs earning income eligible for the small business deduction are likely to see the tax rate drop from 14% to 12% in 2016.2 Accordingly, CCPCs may wish to maximize any discretionary deductions (such as capital cost allowance), available to them in 2015. Non-CCPCs and CCPCs earning active business income in excess of CA$500,000 will see the tax rate increase from 26% to 27%. Accordingly, non-CCPCs and CCPCs earning active business income in excess of CA$500,000 may wish to defer taking discretionary deductions until 2016 or later.
1 Existing Capital Gains Reserves could also be accelerated into 2015.
2 We have assumed that the reduction in the federal small business rate from 11.0% to 9.0% proposed as part of the Liberal Party's platform will be effective January 1, 2016. However, it is possible that this reduction will be phased in over a number of years, similar to the reduction introduced in the Federal 2015 Budget (which introduced such a reduction over the course of the next four years).
Dentons is a global firm driven to provide you with the competitive edge in an increasingly complex and interconnected marketplace. We were formed by the March 2013 combination of international law firm Salans LLP, Canadian law firm Fraser Milner Casgrain LLP (FMC) and international law firm SNR Denton.
Dentons is built on the solid foundations of three highly regarded law firms. Each built its outstanding reputation and valued clientele by responding to the local, regional and national needs of a broad spectrum of clients of all sizes – individuals; entrepreneurs; small businesses and start-ups; local, regional and national governments and government agencies; and mid-sized and larger private and public corporations, including international and global entities.
Now clients benefit from more than 2,500 lawyers and professionals in 79 locations in 52 countries across Africa, Asia Pacific, Canada, Central Asia, Europe, the Middle East, Russia and the CIS, the UK and the US who are committed to challenging the status quo to offer creative, actionable business and legal solutions.
Learn more at www.dentons.com
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances. Specific Questions relating to this article should be addressed directly to the author.