Taxation of Investment Income: Understanding Types, Rates, and Exemptions in Canada, Slides of Finance

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Taxation of Investment Income

Personal Income Taxation

The Elephant in the Room

• Tax considerations are a

factor all financial

decisions.

• Our governments

participate in almost

every transaction in our

lives…without negotiation

or notice.

Key Concepts

• Income Tax Act of 1917 – a temporary tax measure
• Canadians are taxed on their world-wide income
• 1972 – capital gains became taxable in Canada
• 1990s under Paul Martin, moved to raise tax revenue and cut Federal

Spending:

• Removed indexing of brackets and deductions
• Converted most deductions to non-refundable tax credits
• Downloaded responsibilities to Provinces
• Progressive nature of personal taxation in Canada
• Social, economic and political objectives of the Income Tax Act
• Deferring income tax is beneficial to the taxpayer because of the time

value of money

Personal Income Tax

• You can access many resources from Canada

Customs and Revenue Agency’s web site

(including downloadable forms in PDF format)

at:

http://www.ccra-adrc.gc.ca/menu-e.html

• Check out the course website for refreshed

links

Non-taxable Income

You do not have to include certain amounts in your income, including the following:

• any GST/HST credit or Canada Child Tax Benefit payments, as well as those from related provincial and territorial programs;
• child assistance payments and the supplement for handicapped children paid by the province of Quebec;
• compensation received from a province or territory if you were a victim of a criminal act or a motor vehicle accident;
• lottery winnings;
• most gifts and inheritances;
• amounts paid by Canada or an ally (if the amount is not taxable in that country) for disability or death due to war service;
• most amounts received from a life insurance policy following someone's death;
• most payments of the type commonly referred to as "strike pay" you received from your union, even if you perform picketing duties as a requirement of membership; and Note Income earned on any of the above amounts (such as interest you earn when you invest lottery winnings) is taxable.
• most amounts received from a Tax-Free Savings Account (TFSA). For more information, see guide RC4466, Tax-Free Savings Account (TFSA).

2009 Marginal Rates of Income

Tax

FEDERAL TAX RATES: Taxable Income Tax Rate $0 - $40,725 15% $40,726 - $81,451 22% $81,452 - $126,264 26% $126,264 + 29%

ONTARIO - PROVINCIAL TAX RATES: Taxable Income Tax Rate $0 - $36,848 6.05% $36,849 - $73,698 9.15% $72,699 + 11.16%

1 7. 5 % 37 , 885

40726 37 , 885 Federal (^) − = 

  ∆=^ −

1 2. 29 % 36 , 020

Provincial 36 ,^84836 ,^020 − = 

  ∆=^ −

No change in rates over 2008 Brackets adjusted upward.

Marginal Tax Rate

• That rate of tax you will pay on the next dollar of income.
• This is the rate you should use when making investment decisions…because investments lead to you receiving incremental investment income (dividends, interest or capital gains)
• It is the after-tax returns you will expect from your investment that are relevant for

investment decision-making.

When Might You Use a Marginal

Tax Rate?

• Whenever you are evaluating an incremental decision:
• For example:
  • When evaluating an investment decision to determine the net after-tax rate of return.
• For example if you want to find the marginal after-tax rate of return on

interest income of 10%

interestrate

(1-marginaltaxrate)

MarginalAfter-taxrateofreturnon10%interestassuminga40%marginaltaxrate:

= =

Tax Deduction

• Is amount that you are allowed to deduct

from income in the process of calculating your

taxable income.

Tax Credit

• Is a direct reduction of tax otherwise payable.

Examples of Tax Deduction used in determining Taxable

Income

Income: From employment $50, Net Business Income 10, TOTAL INCOME $60, Less Deductions: RPP $4, RRSP 8, Annual Union, Professional Dues 2, NET INCOME $46, Less Other Deductions: Northern Resident Deduction 1, TAXABLE INCOME $45,

Taxable Income

• Is the ‘base’ upon which your personal tax

liability is determined.

Eg. In the lowest tax bracket: Federal Taxes = taxable income *15% = $10,000 *. = $1,

Taxation of Investment Income

• Investment income includes:

• interest
• dividends
• capital gains

Taxation of Interest Income

• interest is taxed at the person’s marginal tax

rate