IAFP conference update: Talking to the taxman

(October 3, 2005) As Ottawa looks for ways to reduce tax leakage on the income trust front, just a few blocks from Parliament Hill an intimate meeting of some 170 Registered Financial Planners were plotting ways to manipulate the current tax rules to ensure their clients pay the smallest tax bill.

Financial planners and the CRA at times seem diametrically opposed. This point was made most clear during the Institute of Advanced Financial Planners’ annual symposium in Ottawa last week, when the group’s members took aim at a CRA speaker, chastizing the tax agency for being too harsh in its methods.

Since the CRA isn’t going to change its ways, the visiting RFPs were all ears when Gregory Sanders, a tax lawyer with Soloway Wright, stood up to offer his views on the taxation of an investment portfolio.

His first bit of advice: avoid investment holding companies. “I don’t have anything really positive to say about them,” he says. His reason is simple — a Canadian-controlled private corporation earnings investment pays just under 50% tax on investment income while personal income is taxed at a rate of 46.5%. “You have almost a 3.5% loss just by using an investment holding company,” Sanders says, “that’s a major hurdle.”

A Canadian investment holding company can be useful tool when set up to avoid a U.S estate tax, Sanders says, but from a tax perspective there are few additional benefits.

Rather than develop a sophisticated tax shelter there are easier ways to lower a client’s tax burden. One approach financial planners might consider is to see if there is a way to make their client’s borrowing tax deductible.

Sanders uses the example of a small business owner who can borrow against the business. A small business owner that has a mortgage on his house and equity in his company can take the money in his company and use it to pay off his house. Then, with the home paid off, the business owner can then borrow against the house to return the equity back to the company.

It’s an option, as Sanders explains, since the loan interest on a mortgage is non-deductible. That’s not the case with loan interest on a business.

Of course, tax savings can only take a portfolio so far. Getting off on the right start with a client is always important. As Brian Phillips, a portfolio manager with Phillips, Hager & North, told the IAFP gathering, 94% of volatility in any portfolio comes from asset allocation. The burden lies on the financial planner to make sure a client’s portfolio is properly structured. “If you were able to manage expectations through 2000 to 2004 then you probably still have your client,” he says.

Take the time to prepare a proper investment policy statement, says Phillips. The IPS should reflect the investment objective. The main reason for articulating a long term IPS is to protect the portfolio from ad hoc revisions during short term market fluctuations.

“It is all too easy to make the wrong decisions at the wrong time for the wrong reasons,” he writes in the opening of a paper he delivered at the conference. “Committing the policy to writing is the best shield for long term polities to be defended from the attacks of acute short-term data and market distress.”

Clients will come to appreciate it. Just ask Warren Baldwin, regional vice-president of T.E. Financial Consultants. After September 11, 2001, he got a call from one of his clients. Holding the phone an inch from his ear in anticipation of a dressing-down, he was surprised that the client had actually called to thank him. The client’s portfolio was down, but only a little bit.

Writing down investment objectives and knowing your client are both good advice. Finding some shelter from taxes doesn’t hurt either. Both are topics that will certainly be revisited when the IAFP meets for its next symposium a year from now in Victoria.

Filed by Mark Brown, Advisor.ca, mark.brown@advisor.rogers.com