April 2013

The 2013 Federal Budget

The 2013 Federal Budget recommended a number of proposals that will impact the financial, tax and estate plans of Canadians. We feel the following items will be of particular interests to our clients:

• Lifetime Capital Gain Exemption Increase (LCGE) – the current LCGE for individuals of capital gains realized on the disposition of private company shares or qualified farm/fishing property is $750,000. The 2013 budget proposes an increase of $50,000 to $800,000 beginning in 2014. In addition, the LCGE will be indexed to inflation for taxation years after 2014. The new LCGE limit will apply to all qualified individuals, even those who have previously used the LCGE.

This increase may seem small but through careful planning, business owners could multiply the exemption amongst family members to maximize tax savings.

• Non-Eligible Dividend Tax Credit – the budget proposes an increase to the effective tax rate on non-eligible dividends. Non-eligible dividends are any dividends issued by a Canadian Corporation (public or private) that are paid from earnings subject to a preferential tax rate (such as the small-business rate). The changes will increase the highest marginal tax rate on these dividends to 38.13% for Ontario residents at the top marginal tax bracket.

This change might prompt individuals and small businesses to rethink the annual salary dividend mix of their income.

• 10/8 Strategies – Typically, a 10/8 strategy is used when an individual (or corporation) invests money in a life insurance policy. The owner would borrow (generally at 10%) an amount equal to the amount invested, secured by the insurance policy. The money borrowed would then be used to purchase income-producing assets within the insurance policy (earning generally 8%) to qualify for an interest deduction. The purpose of the strategy is to maximize the annual interest expense deduction while at the same time earning tax sheltered income within the insurance policy. An individual in the highest tax bracket in Ontario would deduct about 45% of the interest expense to, in effect, earn a “free” spread of roughly 2.5% between the after-tax interest cost and the interest earned in the life policy. The budget proposes that for tax years ending on or after March 21, 2013, where a life insurance policy is assigned as security on a borrowing, and interest earned in the policy is tied to interest payable on the borrowed money, the deductibility of interest on borrowed proceeds will be denied. Furthermore the deductibility of premiums paid under the life insurance policy will also be denied. Any benefit relating to an increase in a corporation’s Capital Dividend Account by the death benefit paid under the life insurance policy after 2013 will cease to exist.

Taxpayers will have until the end of 2013 to unwind these policies or lose tax benefits associated with them.

• Leveraged Insured Annuities (LIAs) – A LIA involves the use of borrowed funds in connection with the purchase of a life annuity and a life insurance policy. Typically, borrowed money would be used to fund the purchase of an annuity, the payout from which would fund life insurance premiums and cash to the taxpayer. Upon death of the insured, the borrowed money would be repaid out of proceeds from the life insurance policy. The benefits of such a strategy are similar to the 10/8 strategy above namely: deductibility of interest on the borrowed money, deductions in respect of insurance premiums paid and tax-free capital dividends where applicable. The budget proposes to eliminate the deductibility of premium and credit to the capital dividend account. As well, annuity income will be taxed annually and the annuity will have a fair market value on death equal to the cumulative premium paid.

It should be noted that grandfathering will exist provided no borrowing occurs after March 20, 2013.

• Donation Super Credit – for the next 5 years (2013-2017), the federal government is providing an additional 25% donation tax credit for donations up to $1000 annually by first time donors. An individual is a first time donor if neither they, nor their spouse or common-law partner have claimed donation tax credits in the last 5 years

This credit is only available on cash donations and is not available on in-kind transfers of securities or mutual funds to charity.

For further discussion on how the 2013 federal budget could impact your personal situation, please contact our office or speak with your tax professional.