Concise Tax Summary for Securities Investing as a Canadian
2024-03-20 09:00:34 +0900
It is crucial to acknowledge that each individual's tax circumstances are distinct. The information provided below is a short, general, and incomplete summary. You should seek guidance from a tax professional to find the best approach for your situation.
TFSAs, RRSPs, and RRIFs
A tax-free savings account (TFSA) is a way for individuals who are 18 or older and who have a valid social insurance number (SIN) to save money tax-free throughout their lifetime. It lets you contribute up to a certain amount annually (the annual TFSA limit for 2024 is $7,000). Income growth in the account is tax-free, and withdrawals are tax-free, but unlike RRSPs, contributions are not tax-deductible. There are Self-directed TFSAs and financial institution-managed TFSAs. However, you must open the TFSA at a qualified financial institution, credit union, or insurance company. Penalties for excess contributions or prohibited or non-qualified investments, especially for non-residents, are severe, so care is needed.
A Registered Retirement Savings Plan (RRSP) is a tax-deferred saving and investment vehicle for retirement. Deductible RRSP contributions can reduce your tax to a certain amount. RRSPs also have advantages for dividends from U.S. stocks. Any income you earn in the RRSP is usually exempt from tax as long as the funds remain in the plan. When you turn 71, you must convert your RRSP to an RRIF, as failure will cause you to be taxed on the entire amount.
A Registered Retirement Income Fund (RRIF) is an instrument for paying out funds that have been compounding without tax in an RRSP until now. The money is tax-sheltered while in the RRIF fund but is taxed as it is withdrawn. An RRSP must be converted into an RRIF by the end of the year that the holder turns 71. As an RRIF is a fund disbursement instrument, the holder of an RRIF cannot add money to it. The fund must pay out a certain amount in the year following the year the RRIF is entered into and all subsequent years.
In summary, the difference between an RRSP and an RRIF is that an RRSP is an instrument to encourage retirement savings by providing tax reductions. Contrastingly, even though an RRIF is also a tax-sheltered account, its primary purpose is to provide income in retirement according to a fixed schedule.
Finding out your TFSA contribution and RRSP deduction limit
Your TFSA contribution room is the maximum amount you can contribute to your TFSA and can be found at TFSA annual limit amount. However, given the extremely severe penalties for over-contribution, it is best to confirm your allowed contribution amounts directly from the CRA.
Your RRSP deduction limit is indicated on your latest notice of Assessment or Reassessment after your tax return (T1028) is processed. The annual contribution amount is 18% of your earned income, up to annual limits ($31,560 in 2024). Again, there are penalties for over-contribution, so it is best to confirm the actual amount directly with the CRA.
Capital gains and losses on stocks, bonds, etc
A capital gain is an increase in the value of a stock (or other investment or asset) from the original purchase price. When the price of your stock increases, compared to the purchase price, you have a taxable capital gain. Capital gains start "unrealized" but become "realized" and taxable when you sell the stock.
Similarly, there is a capital loss when your stock decreases in value. Realized capital losses can offset capital gains, reducing tax obligations. If you only have capital losses, you can use a capital loss to offset a capital gain anytime in the future or even for capital gains declared in the previous three years, underlining the importance of good record keeping.
Capital gains tax rate in Canada
In Canada, 50% of the value of any capital gains is taxable. When you realize a capital gain in Canada, you add 50% to your yearly income. The exact impact will depend on your marginal tax rate based on income, province of residence, and other factors.
Adjusted cost base (ACB) = book value (the original purchase price of the investment) plus costs to purchase it, such as transaction costs. If you buy shares at more than one price, you need to use the average volume-weighted price for the adjusted cost base when selling them.
Prohibition against superficial losses to offset capital gains
The CRA permits offsetting capital gains with losses but frowns upon unwinding a stock position only to repurchase it soon afterward. If the CRA decides that a realization of loss was short-term and for tax purposes only, it can deem it a "superficial loss," you will be unable to use it to offset the capital gains.
Interest
Interest earned on bonds, T-bills, GICs and other instruments is taxable at the same marginal tax rate as ordinary income.
Canadian Dividend Income
Payments made by Canadian public corporations to their shareholders get preferential tax treatment for either eligible or non-eligible dividend tax credits
Your T5 statement of investment income notes whether your dividend is eligible or other than eligible. Some other statements that may include dividend income are:
- T4PS statement of employee profit-sharing plan allocations and payments
- T3 statement of trust income allocations and designations
- T5013 statement of partnership income
Eligible vs. other than eligible dividends
Eligible dividends come from a corporation’s income already taxed at the general corporate tax rate. The dividend increases your taxable income, but the subsequent tax credit will offset that. Non-eligible dividends, referred to as “ordinary” dividends, come from income taxed at a lower small-business tax rate and benefit from a slightly lower dividend tax credit.
The tax rate for dividends from Canadian stocks includes a “gross-up.” You must add dividends to your income at a rate slightly higher than what was received and then pay with after-tax dollars. Eligible dividends are grossed up by 38%, and other than eligible dividends by 15%. Add your grossed-up dividend to your other sources of personal income to get your total income, which you can then use to find your marginal tax rate.
Foreign Stocks
Tax Treatment of Shares of Foreign Corporations
Canadian tax residents who invest in shares traded on foreign stock exchanges are not usually required to file an income tax return in the foreign country unless there is some other reason, such as citizenship, as there is usually withholding tax at the source. However, exact rules vary from country to country, and you must always report all income and capital gains from foreign share holdings on your Canadian income tax return.
The adjusted cost base, ACB, of foreign share purchases is calculated in Canadian dollars. If you converted Canadian dollars for the purchase, you should use the exchange rate of the transaction. If you used foreign currency to buy or sell shares, you can use the Bank of Canada conversion rate on the settlement date.
Dividend income from a foreign corporation does not qualify for a dividend tax credit as it does for qualified Canadian shares. You must pay tax on 100 percent of the distribution before deducting the withholding tax. I.e., dividend distributions (and other types of distributions that might otherwise be considered capital gains) that foreign non-resident corporations make to Canadian shareholders are typically regarded as foreign dividends. As such, they would be 100 percent taxable. Distributions from U.S. company shares, categorized as capital gains or a return of capital for U.S. taxpayers, will usually still be considered 100 percent taxable to you as a Canadian taxpayer. You must report the gross foreign dividend (before withholding tax) on your Canadian income tax return and pay tax at your marginal tax rate. Although time-consuming, you can then claim a foreign tax credit for foreign withholding tax paid to alleviate double taxation when you file your tax return (Line 40500 – Federal foreign tax credit). However, the rules limit the foreign tax credit that can be claimed, and due to the foreign tax credit limit, your foreign equity dividends may end up being taxed at a global tax rate that is higher than your regular marginal tax rate.
The exchange rate for foreign dividends is the rate on the date your foreign dividend income was received. However, to keep things simple, you can use the average annual exchange rate published by the Bank of Canada for your entire basket of dividends received in a year.
As mentioned, shares held in an RRSP or RRIF are usually not subject to withholding tax. However, when the foreign shares are in a TFSA, withholding tax will be deducted and cannot be recovered, making TFSA accounts less preferable for holding foreign shares. Also, keep in mind that US estate tax may be payable by Canadian residents on US assets (including securities) owned at the time of death.
This article is licensed under a Creative Commons Attribution 4.0 International license.