Are wealthy clients affected by further changes to top tax rate?

Tuesday’s budget made changes to reflect the new top marginal tax rate of 33%, which was originally announced in December 2015.

These measures will apply to the 2016 and later taxation years.

Read: Essential reads on the federal budget

What this means

The amendments don’t change much for top earners—if they earn more than $200,000, they’ll still be taxed at the 33% rate, say experts.

“The consequential changes are not a surprise,” says Wilmot George, vice-president, Tax, Retirement and Estate Planning at CI Investments. “The changes are a natural follow-up to the decision to increase the top marginal rate.”

Jason Safar, tax partner at PwC, adds, “The news on this was in December when they bumped the top rate by 4%. This is really about the mechanics to make sure it gets done across the Income Tax Act.”

While the federal government has made changes to reflect the new top rate, some provinces haven’t. In particular, Ontario is lagging behind when it comes to charitable tax donation credits.

Further amendments to the Income Tax Act will:

• provide a 33% charitable donation tax credit (on donations above $200) to trusts that are subject to the 33% rate on all of their taxable income;
• apply the new 33% top rate on excess employee profit sharing plan contributions;
• increase from 28% to 33% the tax rate on personal services business income earned by corporations;
• amend the definition of “relevant tax factor” in the foreign affiliate rules to reduce the relevant tax factor from the current 2.2 to 1.9;
• amend the capital gains refund mechanism for mutual fund trusts to reflect the new 33% top rate in the formulas that are used in computing refundable tax;
• increase the Part XII.2 tax rate on the distributed income of certain trusts from 36% to 40%; and
• amend the recovery tax rule for qualified disability trusts to refer to the new 33% top rate.

Read: Another tool gone: linked notes

“When you’re looking at an Ontario donor, the credit they’re getting is at a much lower rate than their top rate of tax,” says Safar. “So they’re disadvantaged compared to a donor in Alberta or B.C. The provincial government here has chosen not to adjust the donation credit to reflect the actual top marginal rate that’s being incurred in Ontario.”

He uses a simplified example. Say a high earner’s total tax rate is 50%–35% federal and 15% provincial. She makes a $100 donation and should get a total $50 tax credit.

“What’s happened is the feds have said, ‘Yes, when you make that $100 donation, we’ll give you the $35 tax credit.’ But the province says, ‘We’re not going to give you the $15 tax credit. We’ll give you $10.”

Safar adds, “They’ve intentionally not done the housekeeping, which is a disadvantage.”

Tips for wealthy clients

Here are some options to help clients with income above $200,000.

Roll investments into a holding company

If individuals have income-earning investment portfolios and are in the highest marginal tax rate, they’re looking at paying about 54% tax in Ontario.

“If they took those investments and rolled them into a holding company, they would only pay about a 50% corporate tax rate,” says Aaron Schechter, tax partner at Crowe Soberman. “There’s a little bit of a deferral there. You’d have to have a very large portfolio for that to make sense.”

Read: Budget narrows access to small biz deduction

Take advantage of capital gains through buy-and-hold strategies

“Anything that triggers a capital gain is clearly the most favoured income type,” says Safar. He suggests buying assets that accrue in value and holding them for the long term.

“If I have $100,000 and I buy a bond and it pays me interest income every year, then every year I get taxed on that income. If I take that same $100,000 and buy a stock, then I sit on that stock for 15 years, I have no taxable event if it’s not paying any dividends.

“When I sell, that’s the only time I have to pay taxes. And I’m paying taxes at half the rate, compared to my tax rate on interest income.”

Kevin Stienstra, senior manager, Tax Services at Grant Thornton notes high-income earners didn’t “get much solace” from the budget.

“It’s still going to cost those taxpayers to look for different tax strategies to reduce their income or split their income so they’re not paying tax at that rate,” says Stienstra.

He adds the new top rate hurts Canada’s economic competitiveness. “We would’ve liked to see them repeal that increase. Canada has the second highest [tax rate] among the G7 countries, with only France ahead of it. So if a doctor or other professional is looking for places to work, and they’re taking into consideration how much they’re able to take home after tax, Canada is not overly competitive.”

Read more of our budget coverage.