Tax Saving Idea for Couples: the Superficial Loss Shuffle

"Superficial loss shuffle" is such an appealing name and the concept itself has the amusingly ironic quality of turning the CRA's superficial loss rules, which normally disallow tax advantages to an investor, on their head and give an advantage instead to the couple with investments in separate taxable accounts, one of which has capital gains and the other losses.

The idea is that the spouse with the losses be able to transfer them to the spouse with the gain and eliminate any tax owing. The idea and the description of how it works is here on the CCH website in Tax Planning in a Downturn in the February 2009 issue of the Financial Planning eMonthly newsletter under the pen of lawyer and accountant David Louis.

Note that the CRA prescribed rate of 3% mentioned in the article is now down to the can-never-go-lower rate (since it must be a positive whole number) of 1%.

Investing an Inheritance: How to do a "File and Forget for Forty Years"

Most of us save for retirement in tax-deferred accounts like RRSPs and LIRAs. But what happens when you suddenly receive a large lump sum and you do not have RRSP contribution room, in other words you must invest in a taxable account?

Here's a situation I've come across recently that got me thinking and researching. (Initially, I thought it was simple but it has taken me some time to figure it out to get the practical details right.)

Situation:

• $50,000 inheritance, specified in the will to be "for retirement"; a very wise thing the person who died has done, creating a very strong moral, if not legal impediment to spending the money since half the battle of saving is actually doing it; I would note in passing that the person receiving the inheritance does not have to include the amount in income and pay tax since that would already have been done in the process of settling the estate; I would also note that it is not a testamentary trust, which could absolutely ensure that the money not be touched till retirement.
  
• 40 years till retirement; the person is in his twenties so the planning horizon is at least that long; due to the above-noted restriction on the lump sum, it is highly likely that the actual time horizon will correspond to the planned horizon - in other words, people frequently suddenly decide that their "retirement nest egg" needs to be cracked open for an omelette craving today, thus blowing the value of a long term approach to smittereens.
  
• No RRSP room: the inheritance must go into a taxable account, which means that income taxes for various types of investment returns (interest, dividends and capital gains) can play a crucial role in net returns, especially over the long term; though the person could or should intend to move the investments progressively into an RRSP as his career advanced and contribution room became available, in this case, his apparent career orientation into government or educational jobs suggests that one of those golden defined benefit plans will use up most or all of tax-deferred pension room, so it is better to plan as if it will not happen
• Maximize net after-tax wealth: obviously ... but he is not interested in high-risk investments that may suffer absolute final losses, as opposed to waiting through market ups and downs, and subject to the following constraint,
  
• Zero maintenance and attention portfolio: the person would ideally like to have to do nothing at all for forty years! No buying and selling, no rebalancing, nothing, if at all possible; unfortunately, it is still required to file a tax return every year, so tax reporting simplicity is a consideration. As a consequence, things should be as simple as possible - few holdings at one broker.

General Principles: these should always apply to investing

• low costs - paying higher fees for others to manage your investments is a sure way to end up with less; 0.1% less per year can add up to many thousands difference after 40 years - 4.1% return compounded will see $50k reach $240k while 4.2% yields $249k; high MERs = low net returns; this eliminates from consideration all equity mutual funds except index trackers
  
• diversification - the "not all eggs in one basket" and "some go up while others go down" factors entail being invested in many assets with as low as possible correlation with each other; this ensures that there is a net gain, not a loss, over the long term
• tax-effectiveness - deferring and reducing taxes means a greater net in the future; tax rates in Canada are lowest on dividends, higher on capital gains and highest on interest as this previous post on tax rates shows. There is a significant advantage to dividends for all taxable income up to the mid-$70k range, which is where our person is most likely to end up based on his career path. However, the portfolio diversification principle must be respected - meaning that it is not acceptable to ignore the fixed income component of a well-structured portfolio merely to avoid taxes. Fortunately, there is a way - substitute preferred shares returning dividends for bonds returning interest income.
  

The Proposed Solution: this is necessarily a combined solution of portfolio and broker/financial service provider due to the practical constraints outlined below; theory may tell us to do things a certain way but it is not quite possible in practice.

There are three good alternative solutions, the best ranked first.

1. Portfolio of Four ETFs at Questrade

Portfolio Composition:

• 35% / $17,500 XIC - iShares Canadian Composite Capped Index Fund, MER 0.25% (the alternative is XIU, the TSX 60 fund, which has a lower MER of 0.17% and distributes much less income as interest, but it only includes the 60 largest companies as opposed to the 270+ companies in the Canadian market, which means less diversification as the 60 only account for three-quarters of total market value of the TSX and presents less opportunity to benefit from small company growth, from income funds and from real estate); negatives of XIC are the MER and the fact that some of the annual distributions are higher-taxed interest; XIC exemplifies the simplicity and advantage of a fund that enables one to own a piece of a large number of assets/companies through one purchase; in the proposed portfolio XIC is the Canadian equity asset class
• 15% / $7,500 VTI - Vanguard Total Stock Market ETF, MER 0.07%; this is a broad market index, representing some 95% of the total US market according to Vanguard; it is exposed to USD vs CAD currency swings, which can be good or bad, depending on the direction; to some degree, there is also a diversification advantage (see discussion in a Burgundy Asset Management paper and research by Mark Kritzman - when the Canadian market falls, often the Canadian dollar follows, meaning that a VTI owner will end up with more Canadian dollars (as long as the US market doesn't fall by the same percentage); alternatives might be IYY and IWV, two index ETFs that track the broad US market but they have higher MER of 0.20%
  
• 20% / $10,000 VEU - Vanguard FTSE All-World ex-US ETF, MER 0.25%; provides very broad exposure to some 1300 companies in 47 countries around the world outside the USA
• 30% / $15,000 CPD - Claymore S&P TSX CDN Preferred Shares ETF, MER 0.45%; this is the fixed income portion of the portfolio, in which preferred shares are substituted for the bond funds typically held in registered tax-deferred portfolios; preferrred shares produce dividends so the person in a middle tax bracket will lose only about 8% to tax vs 30% - preferred shares pay less than bonds (James Hymas says about 0.89% for corporate bonds) in an article Corporate Bonds - or Preferred Shares? in the May 2006 Canadian MoneySaver) but compound the tax difference over 40 years and the difference is enormous e.g. 6% gross on $15,000 bonds would net reinvested and compounded after annual tax at above example rates $77,767 in bonds and 5.1% on dividends would net $93,892; note that bond funds always include lower yielding government bonds so this comparison understates the after tax advantage of preferred share dividends; the alternatives to CPD are three closed end funds DPS.UN - Diversified Preferred Shares Trust, PFR.UN - Advantaged Preferred Share Trust and PFD.PR.A - Charterhouse Preferred Share Index Corporation according to Portfolio Construction in the July/August 2007 Canadian MoneySaver issue but a cursory look suggests they suffer from making large distributions of return of capital, which is just giving his own money back to an investor, as well as trading often at well-below NAV.

Why the portfolio allocation proportions and holdings?

This is perhaps the most uncertain area. While the whole world is represented, Canada has a much larger proportion of total equity - equal to the sum of the USA and the rest-of-the-world - than in my own portfolio. The logic is simply that the person is likely to live and retire in Canada and use Canadian dollars. The foreign holdings introduce a significant enough exposure to diversification benefits from the equities themselves and from currency swings, but not too much. I've wrestled with this in the past e.g. this post on IFA Canada's model portfolio and this post on my own portfolio but cannot find the "perfect answer".

What does the above portfolio achieve?

• diversification through diffuse ownership of a large number of companies
• diversification through investment in most areas of the world
• diversification through equity and fixed income asset classes that move in different ways at different times (but which all move upwards over the long term)
• higher net returns through low fees of the ETFs
• higher net returns through use of a discount broker, which will charge nothing for account administration or management and only charges for trading
  
• higher net returns through lower taxes
• zero maintenance through index tracking - the fund managers regularly restructure the holdings to reflect market evolution requiring nothing of the investor
  
• zero market knowledge and investigation required - you get the market average automatically year after year, sometimes that is down but mostly it is up and certainly over the long term it is up
• zero maintenance through automatic dividend/distribution reinvestment by Questrade
  
• minimal administration through the small number of funds requires less work to do annual tax returns for distributions and down the road when they are eventually sold
  

What does it not achieve and what are the risks?

• rebalancing to keep the portfolio proportions the same will not happen without selling and buying by the investor; rebalancing every four years or so, or when one holding gets more than 5% (e.g. XIC goes up to 41% or down to 29%)out of whack, is the optimal strategy (see this post for discussion); over many years, the equity investment growth should far outstrip the fixed income CPD, which will increase the overall riskiness of the portfolio; normally, that's a cause for concern and the reason for rebalancing; in this case it is quite possibly a good thing, a worthwhile natural evolution. Why? As this person gets older and if, as expected, he begins to build up a defined benefit pension plan paying a fixed inflation-adjusted income at retirement, that in effect has increased the fixed income portion of his total personal wealth.
  
• shifting the portfolio into an RRSP for tax deferment and tax-protected growth as and when that becomes possible can only happen with monitoring and action by the investor; contributing the funds in-kind is possible but that will trigger a deemed disposition and the necessity to calculate and declare capital gains along the way, more work for the investor; the first thing that should go into the RRSP is fixed income, but the CPD should then be sold and replaced by a purchase of a bond fund like XBB the iShares Canadian Bond Index Fund since bonds will produce a higher gross and net (once protected from taxes) yield
• keeping a record of the Adjusted Cost Base of ETFs is a manual procedure as I explained in this post and it is a pain in the you-know-where; it doesn't really need to be done till the ETF is sold and the gain is to be reported on a tax return so maybe it can be put off and done in one massive catch-up session after 40 years but I'd want to not be further than five years behind simply because corporate fortunes rise and fall, companies come and go and records disappear or become hard to find (I had a lot of trouble some years back trying to figure out mutual fund ACBs to do final returns going back a mere 20 years)
• potential instability of the solution is an inescapable risk, especially over forty years, since the practical evolves greatly e.g. forty years ago, index funds did not exist and there was no capital gains tax in Canada; change will happen, it's just not possible today to know where, when and to what degree; one thing to remember is that big does not equal absolutely safe, stable or permanent - the current financial turmoil is affecting most the world's biggest banks, some will fall and over the long term, most will fall (just check the stock listings of the TSX, oops it used to be the TSE, 40 years ago and see how many names you recognize); Questrade is a relatively new, smaller player and going with them entails a degree of risk that it will be necessary to shift the portfolio to another institution if they run into business problems ... or maybe their superior product will see them grow into the dominant broker of tomorrow; is CIBC a good place to be, they seem to keep stumbling? Regardless, it will always be necessary for the investor to keep a general eye on developments for this maximum passivity portfolio.
  

Broker: All ETFs produce cash distributions, either monthly, quarterly, semi-annually or yearly, and there is no option, like there is with mutual funds, to have the ETF manager reinvest the cash automatically. So the investor can do it at his own time and expense or a broker can offer the service. But the objective is to have everything run on autopilot. The choice of Questrade boils down to one thing - Questrade is the ONLY Canadian discount broker I found that could reinvest the cash distributions for all the above ETFs so that the cash would not sit around in the account earning little or nothing. CPD was a particular no-can-do for everyone but Questrade and we see above above, it is a key element of the plan.

2. Portfolio of DFA Mutual Funds described on IFA Canada from Advisor De Thomas Financial.

This approach consists of handing over the $50k to De Thomas Financial for them to invest in the DFA mutual funds described in detail on the IFA Canada website. They follow passive indexing principles to the nth degree, they say convincingly enough (i.e. they back up their assertions with believable data) even more than the various index ETFs. The breakdown of asset classes is more numerous, enabling reductions in volatility and higher returns. Though De Thomas charges a 1% annual fee on top of the 0.25-0.70% embedded in DFA funds, their approach makes up for that 1.25 to 1.7% vs 0.07 to 0.45% ETF fee spread by lower tracking costs, by stock lending revenue and by tax deductibility of the fees (on taxable accounts only). Michael Hill of IFA Canada & De Thomas explained all this in my Q&A blog post of Oct.23. The end result is that the investor should attain a higher net return. The fact that the holdings are mutual funds eliminates the special ACB record-keeping hassle of ETFs, as well as the reinvestment of distributions problem. The rebalancing issue goes away too since De Thomas does it. Finally, part of the De Thomas service is general financial advice (I notice that Mr. Hill is a Certified Financial Planner, one of the better designations) and that may come in handy.

My biggest concern is that all of the portfolios have only bond funds and none with preferred shares and so taxes will be considerably higher. Another is that the "Easy Chair" portfolio for accounts smaller than $100,000 (the minimum required to do the full asset allocation using all the funds) has some limitations but those are not described.

3. Portfolio of TD Canada Trust e-Series Mutual Funds

This portfolio mimics the ETFs in the first portfolio with the difference that they are mutual funds available only through having an account at TD Canada Trust. The funds are:

• TDB900 - TD Canadian Index Fund, MER 0.31%, tracks the TSX Composite Index (it doesn't appear to be a capped fund like XIC, which limits any stock to no more than 10% of the fund; this shoudn't cause any difference or problem as long as there is no tech bubble II where Nortel gets up to 30% of the total value of the TSX!)
• TDB902 - TD US Index Fund, MER 0.33%, tracks the S&P 500, which is only three quarters or so of the total US market and really only tracks large companies, a disadvantage since small company stock returns historically have outperformed large company returns
• TDB911 - TD International Index Fund, MER 0.48%, tracks the Morgan Stanley Capital International Europe, Australasia and Far East Index("MSCI EAFE Index"), which is probably quite a bit less diversified ( we cannot tell because TD's fund information on the above website is too incomplete) than VEU
• TDB909 - TD Canadian Bond Index, MER 0.48%, tracks the Scotia Capital Universe Bond Index ("Universe Bond Index"); because it's a bond fund in a taxable account this is much less desirable than CPD
  

The TD funds do offer the advantages of mutual funds over ETFs already noted above but the higher MERs and a bit less ideal diversification characteristics promise lower long run returns. The biggest negative is the absence of a preferred shares fund. Of course, it would be possible to take the $15,000 for fixed income, go to Questrade and have an account only for that holding there. But why start to complicate life with accounts here and there if there is a better overall solution with Questrade?

Tax-Loss Selling Index ETFs: How to Do It Right

When December rolls around it is time to look over the portfolio and see where certain holdings are in a significant net loss position to decide whether it is time to lock in the loss to offset against current year or past year capital gains (past year because losses can be carried back or appllied against gains up to three years in the past to reduce taxes and get a refund). The objective is to reduce net capital gains to reduce taxes.

In looking over my own holdings, as shown in the model portfolio at the bottom of this blog, just about everything is showing a loss since I remodelled the portfolio in May and booked a pile of capital gains. Lesson number one is therefore to keep a running total of capital gains to be able to tell at any moment whether it is necessary or advisable to do any tax loss selling at all for this year's return. That's why I have my Cost Base tab in the model portfolio spreadsheet, which I update with every trade. Note that capital losses can be carried forward indefinitely into future years so if you think you may have higher income down the road, it may be beneficial to take a loss now to offset future higher gains. For the passive index investor, present market difficulties and losses presents an opportunity to lock in those losses with the confidence and expectation that sectors / asset classes (e.g. REITs have taken a hammering) will eventually recover. The indefinite carry forward feature of CRA rules means that one doesn't have to try predicting when markets will recover, only that they eventually will recover (if they never do, we are all in deep trouble or if you die before they do, will you care?). Patience is a virtue.

First, I note that one holding - AGG, the US Intermediate Term Bond Fund - has gone up in price in US funds from $99.37 to $100.38 yet it shows a loss in Canadian dollar terms, which is what counts for Canadian tax purposes. The reason for that is, of course, the tremendous appreciation of the Canadian dollar vs the US dollar; in this case, the C$ has appreciated from about CAD1.0920 per USD on May 23 to about 1.0167 today (yup, that's right appreciation means it takes less CAD to buy USD). It is thus very worthwhile to track a portfolio taking into account the shifting exchange rate. Volatile exchange rates can easily and quickly change a net Canadian dollar gain into a loss (or vice versa).

However, most of my portfolio is held within my RRSP or my LIRAs so there is no chance to claim capital gains or losses. Two holdings are in my non-registered taxable portfolio - VV, Vanguard's US Equity Large Cap ETF and VNQ, Vanguard's US REIT ETF. In the case of these two holdings, the USD price loss has been accentuated by the falling USD, creating a significant enough opportunity to spend the commission costs to lock it in.

Note that the Canada Revenue Agency does not require, nor does it accept, the reporting of foreign exchange gains or losses of $200 or less (see page 18 of the CRA's Capital Gains guide T4037).

Note also that the date on which to do the foreign exchange calculation is the settlement date, when you receive the money from a sale, or pay the money for a purchase, NOT the trade date, which is three business days earlier. It is thus a fact of life that the exchange rate will shift, perhaps a lot, between the trade date and the settlement date, so you can never know exactly how much your gain or loss on foreign property will be. Well, perhaps if you had millions at stake it might be worth locking in the exchange rate with a foreign exchange futures transaction but for us hoi polloi, it won't be practical.

The settlement date rule is especially important to note when one is selling right at year end - if the trade date is in 2007 but the settlement date is in 2008, you cannot report the loss on your 2007 return, you must report that in your 2008 tax return, probably not what you want if you are trying to minimize taxes now. Due to normal holidays when exchanges are closed, this year the last trading day for counting transactions in 2007 is Dec.24th. Incidentally, I phoned CRA and asked for a reference to a written guide where this rule on the settlement date is stated but they had none to point me to except general statements like subsection 40.1 of the Income Tax Act which mentions gains or losses are counted when actual value is received.

Incidentally, there are of other things than ETFs to which tax loss selling applies and a good summary of tax loss selling by Kevin and Keith Greenard appeared in the Dec. 8, 2007, Victoria Times Colonist. As the Greenards point out, it is worthwhile to review capital agins reported in the last three years since present year losses can be carried back to offset past tax and obtain a refund.

One tip that can reduce your foreign capital gain or increase your capital loss by about 2% depends on the exchange rate that you use to convert to/from Canadian to US dollars (or other currencies if you are able to trade in such). The CRA accepts as standard the published Bank of Canada rates account and the funds had not passed into or out of actual CAD. Though they could not quote me a written source to confirm this and therefore there may be some doubt they misunderstood what I was asking, which might mean it is incorrect, such a position conforms to the logic of what a real trade would follow. but these are nominal mid-market (half-way between buy and sell) rates not the rate you or I pay to our broker to buy or sell. The commission charged by the brokerage means you get fewer USD when you buy them / buy the US equity, and less CAD when you sell. In the case of BMO Investorline, it's about 1% commission each way, or 2% for a round trip. The CRA told me when I called their public tax info line at 1-800-959-8281 that I could use the actual broker buy-sell rate, even though the purchase and/or sale may have occurred entirely within a USDCRA is not that unfair to force people to use FX rates that understate their costs or over-state their proceeds of sale. In other words, you and I are better off using the broker foreign exchange rate instead of the Bank of Canada rate . The only requirement is that you must document and be able to show the CRA, if they should ever ask, the actual broker rate. I simply took a screen shot image of the BMOInvestorline FX quote for the CAD-USD exchange on my settlement date. You must also use the same method of FX, Bank of Canada or broker rate, on reporting both original purchase and eventual sale. You don't have to follow the same method for all holdings, however - it can vary holding by holding.

Another key rule has to do with passive index ETFs (or mutual funds), identical properties and a superficial loss. If you want to sell for a tax loss but stay invested in the market in the same asset class, you must not buy an ETF that tracks the same index as the one you just sold for the loss. Otherwise, CRA will deny you the loss, i.e. deem it a superficial loss, and treat your transactions as if you had never sold the losing ETF (your adjusted cost base of the new ETF will be considered the same as the old one). That the practical interpretation of identical properties regarding ETFs is such is stated on pages 164-165 in Howard Atkinson's book on ETFs, the New Investment Frontier III (see my review of this book here). Jamie Golombek, with AIM Fund Management at the time, in a Canadian Tax Highlights March 2002 article referred to a Dec. 5, 2001 CRA bulletin (TI 2001-008038) that used the example of two funds which track the TSX 300 from different companies as being identical in CRA's view. I am still awaiting a response two weeks later to my enquiry to CRA's public info line on the matter to confirm this interpretation.

Update January 11, 2008 - a representative of CRA phoned and said that the 2001 bulletin mentioned above is the only and latest information on the subject. He also emailed me a copy. Some key excerpts: "... the determination of whether investment instruments are identical properties requires a review of all the facts of each particular situation which would include a review of the legal structure of the investment entity, the composition of its assets, risk factors, rights of investors and any relevant restrictions. ... a TSE 300 Index Fund, for example, would generally not be considered identical to a TSE 60 Index Fund. ... Accordingly, an investment in a TSE 300 index-based mutual fund of a financial institution would, in our view, generally be considered indentical to an investment in a TSE 300 index-based mutual fund of another financial institution."

In my case, VV tracks the MSCI US Prime Market 750 Index and I bought IVV, the iShares ETF that tracks the S&P 500 Index. By the CRA rule if I now try to sell the IVV and buy SPY, the SPDR S&P500 to lock in further losses (a hefty drop this week), that loss would be disallowed. The VNQ that I also sold tracks the Morgan Stanley REIT Index while my replacement fund, the RWR from SPDR tracks the DJ Wilshire REIT Index. That should not violate CRA's test while keeping me fully invested.

It is thus very handy to keep a list of alternative acceptable ETFs within each asset class, such as the one in the Asset Allocation tab at the bottom of this page. You should also note what index they track to comply with the identical properties rules when selling for tax losses. In my original off-line spreadsheet, I've added that info in the cell Notes, though unfortunately the Notes cannot be displayed in the Google on-line spreadsheet.

A Canadian Investor's Christmas Wish List

It's the time of year that Santa comes around and this year I'd like him to bring me these small gifts:

• the capability to hold foreign cash in registered accounts like RRSPs and LIRAs, starting with US dollars but why not other currencies like GBP, EUR and JPY, to avoid having to settle trades back into Canadian dollars and then to repurchase USD again to re-invest, which incurs foreign exchange commissions on each end and 2% extra trading costs. I had suggestions from one discount brokerage (not one of the big five banks) that it was finally about to launch such accounts this month - fingers still crossed.
  
• discount brokerage accounts, both registered and non-registered, that enable low cost trading ($10 per trade sounds reasonable) directly on other major world exchanges like London, Tokyo, Paris, Frankfurt; TD Waterhouse, this should be especially easy for you since it already exists in your UK service offering
• passive index tracking mutual funds with low MERs (0.3% or less is a good target) like those of Vanguard in the US as a competitive alternative to ETFs; this will enable small purchases, re-balancing and will simplify reinvesting and tax returns. Note to TD Canada Trust - start offering your e-Series index funds through other brokerages and not force people to open an account with you ... oh, and lower those fees a wee 0.10% please; at Christmas you will find that if you give something, you will receive too.
  
• combined account portfolio reports from my discount brokerage for all types of accounts, into one integrated portfolio, to save me the trouble of copying all the data from my regular trading account, my RRSP and my LIRAs into a spreadsheet; a very useful extra capability would be to enable me to add labels of my choosing for asset classes and to summarize that as well across all accounts; plus, capital gains tracking on the regular accounts, to make it easier to do my income tax return plus plan year-end tax-loss selling or gains lock-in.
  
• real tax-exempt savings accounts (wonder if Jim Flaherty reads this blog) from our federal government like the ISAs in the UK, in addition to the tax-deferred RRSPs; it's so much simpler and more flexible - no tax deduction since the funds come from after-tax income but growth is completely tax-sheltered and no tax is due on withdrawal, no matter what the type of investment, one's income or age.
• again from the federal government, an annual tax-exempt capital gains amount, say $10,000, like that of the UK

That's not a lot to ask is it, only six things? And I've been a good boy all year.

Capital Losses and Superficial Loss Rule Using an RRSP

Investoid posted a comment that is worthy of a new separate post. In it he says he was not aware of the tactic to sell a holding in an open taxable investment account to lock in a capital loss then to immediately re-acquire the same holding inside an RRSP.

Oops, should have noticed that in the document before posting. There's a rule of investing - if it looks too good to be true, it probably isn't. It applies here. Or does it? Let us say we have conflicting opinions, including from the CRA itself!

This extract from Chapter 5 of the CRA's T-4037 Capital Gains Guide seems to say no, you cannot do that, the superficial loss rule applies. It states:
''you, or a person affiliated with you, buys, or has a right to buy, the same or identical property (called "substituted property") during the period starting 30 calendar days before the sale and ending 30 calendar days after the sale ....
Some examples of affiliated persons are:

• you and your spouse or common-law partner;
• you and a corporation that is controlled by you or your spouse or common-law partner;
• a partnership and a majority-interest partner of the partnership; and
• after March 22, 2004, a trust and its majority interest beneficiary (generally, a beneficiary who enjoys a majority of the trust income or capital) or one who is affiliated with such a beneficiary.''

In other words, the RRSP is a trust and you are the beneficiary so the CRA says no it isn't allowed. Probably, people started taking advantage too much and the CRA changed the rules in 2004 to stop it.

That's not the end of the CRA story, however. It doesn't actually say trust = RRSP and you = beneficiary. In my zeal to get a definitive confirmation I called the CRA helpline. After a good long wait to get to a rep and then again while he went off to consult with someone, the answer was, the CRA says yes it is allowed, and quoted me from an internal document #2001-008077, written in 2001. When I expressed my doubts and asked him to re-confirm, since I was about to post this on the Internet and I am not out to embarrass the CRA (really!), he said he would get back to me by next Tuesday at the latest. (For those who think badly of the CRA for this, ask yourself whether a service rep at a typical corporate helpline, say Bell Canada's, would even consider looking further into such a matter.) Wouldn't it be nice if the CRA added a specific mention of RRSPs (and RRIFs since they would presumably be similarly affected) to their Capital Gains guide regarding this matter?

Web sources don't seem to agree either, perhaps no surprise. Here's a brief sample of results from a bit of Googling:

No, It is Not
AIM Trimark's Capital Loss Planning
Posting in Canadian Business forum in April 2006
Another posting in Canadian Business from Jan. 2006 that mentions an Altimira Funds publication saying No as well.
CIBC Wood Gundy article on Tax Loss Selling with no date and the added footnote, hilarious in light of the absent date, ''The information contained herein is considered accurate at the time of posting.''

Yes, It is OK
Milestone per the previous post (April 2002)
TaxTips.ca. And it's one of my favorites!
Advisor.ca column by Jamie Golombek (a VP at AIM at the time of writing in Nov. 2002)
Canadian Shareowner article from NovDec 2000
Bylo posting of Jonathan Chevreau article in the National Post from Nov.21, 2000
Sterling Mutuals article Avoid Superficial Losses in Nov.2001
Institute of Chartered Accountants of BC Tax Traps and Tips article Nov. 2003

My bet is on the ''not allowed'' side. Any opinions? I suspect all this is to re-discover the sad truth of stale content on the web and the fact that one cannot necessarily believe everything that is written, even from reputable organizations.

Thanks, Investoid for the topic!

Update Oct.10 - Finally got a call back from Revenue Canada and the answer is now NO, you are not allowed to do it, or more precisely, your capital loss will be declared superficial and denied on your tax return. The relevant subsection is 251.1 (g) of the Income Tax as modified in 2005.

Canada's High-Taxes vs the UK

When I decided to come over to Scotland, I investigated the tax consequences, expecting to find myself paying more tax over here in the UK. I was surprised to find the opposite, in fact, quite the opposite. For my fellow Canadians out there, here's the shocking news - the excess rate of taxation is considerable and across the board in all types of income and investment taxes.

Refer to the chart for all the numbers. I've used Ontario as my benchmark province.
The UK advantages start with the personal exemption of about $11,500 vs only $8839 in Canada. Take your marginal tax rate and compute the savings on the difference.

On income and interest, treated as the same in Canada but taxed at a slightly lower rate on interest in the UK, the Canadian rate is higher in every single tax bracket and the difference is the worst for middle income earners. For example, in the blue highlighted line for taxable income in the $60k range the Canadian marginal rate is 33% vs 22% in the UK. Ka-ching, another difference that could reach into the four figures.

On dividends, the UK has a zero effective rate due to an offsetting dividend tax credit until a person has more than about $76,000 taxable income.

On capital gains, the rate is actually higher in the UK throughout the tax brackets but everyone is given an annual exemption of about $20,150 in net gains. That should suffice to ensure a tax-free existence for most investors of modest means.

Not shown in the chart are the comparable retirement savings vehicles, the RRSP in Canada and the Individual Savings Account (ISA) in the UK. An ISA offers the same tax-free accumulation/compounding as the RRSP. An ISA does not allow a tax deduction as does the RRSP. Instead, any withdrawals are tax-free as opposed to the RRSP where withdrawals are taxed at the rate for marginal income. The RRSP advantage of saving taxes by withdrawing after retirement when one's tax rate would be less is not there for the ISA ... but the UK tax rates are lower in the first place and more uniform up to high levels. In addition, the ISA doesn't create artificial incentives to keep interest bearing securities inside the RRSP and dividend or growth investments outside. For anyone who has struggled with portfolio balancing across both RRSP /LIRAs and regular accounts while minimizing taxes, this ISA feature would be a big boon. Perhaps the biggest plus of the ISA is that the £7,000 annual allocation that is not reduced by contributions to a regular pension plan and thus allows a much high tax-free savings rate if desired.


Though such differences are and were not the motivation for my move to the UK, nor would I advocate moving to another country just to save taxes, it does lead one to ask those people who make our taxes why they are so high.

Taxes on Interest vs Dividends vs Capital Gains

A friend asked about how dividend taxation works and the difference in tax rates between the different types of investment revenue - interest vs dividends vs capital gains. He tried unsuccessfully to figure out the answer browsing through the Canada Revenue Agency's comprehensive but daunting website. Since he, being a smart guy, did not succeed, I figure this is worth a post for someone else's benefit.

I must acknowledge the excellent free Taxtips website, already linked under the Resources sidebar of this blog, for providing the calculators and information that produced the following results, though of course, if I've made any errors of interpretation that's not their fault.

The tax calculation of Canadian dividends goes through a grossing up process of the actual dividends we receive by cheque. Currently, this means adding 45% on top of the actual dividend, and the new higher amount is included in our taxable income. Yikes, you may say, that will raise my taxes! But through a clever tax credit calculation on the amount, the CRA gives it back and we all end up better off. Better even than interest or capital gains. (I'm referring to the most common type of dividends, those paid by companies listed on stock exchanges such as the TSX. See this Taxtips page for the nitty gritty of what is in this category termed "eligible" dividends.)

Use the Taxtips calculator to do your own numbers for your own province. I used Ontario for me and my friend. For almost every tax bracket, dividends have the lowest marginal tax rate, better even than capital gains, which may surprise some. The dividends tax advantage against capital gains diminishes progressively as you go up in tax bracket, being about 1% in the $72k-118k brackets for 2006. In the very top bracket, over $118k, the tax rate is higher on dividends. However, both dividends and capital gains have a significantly lesser tax rate - half or less - than interest or ordinary income (like salary) at all taxable income levels. (See this Taxtips chart, which shows both 2006 and 2007 brackets and marginal rates for Ontario.) That's why we are constantly told to put our bonds, GICs, CSBs and the like into our tax-sheltered RRSP.

Hmm, those banks stocks and utilities look better and better.

Deemed Disposition and Probate

Some years ago when I had to perform the tasks of executor for my wife's will, I was caught in a very unusual unusual situation. Since the the tax rules specify that all of a deceased taxpayer's assets are deemed to be sold as of the date of death, capital gains are liable to be paid on that deemed disposition. That's exactly what happened with Nortel at the time, which only begun its slide by the time of death at the end of September 2000.

By the time the will was probated in December 2000, the stock price had dropped by close to 40%. The capital gains tax payable almost exceeded the value of the stock holding. By the time the estate was ready to be distributed some months later, it did by a good margin. The only way to avoid a huge tax hit was to avail myself of a provision that allows a spouse, and only a spouse, who is to inherit some or all of an estate, to receive his/her share at the original cost of the deceased taxpayer and to avoid deemed disposition of those specific assets. At least the executor, unless the will states otherwise, is at liberty to decide who will receive which specific assets.

This incident revealed to me some interesting characteristics of having a will probated. Financial institutions seemingly will generally (except for things like funeral expenses) refuse to accept instructions of the executor (e.g. liquidating assets) until the will is probated unless the amounts are quite small. This appears to be a matter of the financial institution showing proper care to avoid getting sued later by disgruntled inheritors. Same goes for the executor. There does not seem to be any law that requires a will to have received probate from a court before it can be carried out.

However, even when a will has been probated, if another later will is found and can be shown to be valid then the original probated will does not stand and the executor would have to start all over again. What does all the money paid for probate actually give one then? It can cost a lot of money ($5 per thousand on the first $50k of assets and $15 per thousand on the excess in Ontario). Certainly it doesn't happen very quickly - a matter of months at best.
Does the court check for existence of other wills - no! how could it in practical terms? Does the court even check the accuracy of assets listed in the estate - again, no, unless some lawyers out there can correct me ... some dishonest people might be tempted to understate the total assets, n'est-ce pas? The bottom line is that the probate fee is not a fee for a service, it is a tax on wealth. Why not a flat fee of $150 or some such amount that reflects the actual work involved by the court?