Tax relief for the rich

As noted in background materials released on Dec. 7 by Finance Minister Bill Morneau, the new tax bracket is expected to raise only $2 billion in that fiscal year. Meanwhile, the middle-income tax cut is now expected to cost $500 million more in its first fiscal year than what was predicted in the Liberal election platform. (See table below).

That $800-million shortfall in tax revenue from the high-income tax hike will arise largely because of various income-splitting techniques that create savings for wealthy households and employment for accountants, lawyers and actuaries. This does not include the previous government's family income-splitting program, which in the 2014 tax year provided a tax credit of up to $2,000 for couples with children under 18. That program is being scrapped by the Liberal government.

What remains intact are long-time measures such as family trusts, spousal loans and individual pension plans, all of which are pretty much exclusively the preserve of the wealthy. And while Canadians of modest means have access to programs such as spousal RRSPs and tax-free savings accounts, wealthy individuals are best able to maximize their contributions and reap the greatest tax savings.

More important than any specific tax-avoidance measure, however, is to have a comprehensive wealth-management plan, says Cindy Crean, managing director, private client, with Sun Life Global Investments.

For families, she says, the focus should be on how much tax the entire household pays, rather than what a single family member pays. One of the basic family-planning concepts is, to the extent possible, equalize the tax rates between spouses. This approach will drive decisions on how to invest and in whose name, and what types of tax-efficient vehicles to employ.

Within this household-level framework, the following is a selection of personal tax-planning strategies in 2016. Some are suitable only for high-net-worth individuals and families, and some are more widely available:

Set up a family trust. This strategy involves the higher-income spouse lending money to a trust whose beneficiaries are the lower-income spouse and the couple's children. Crean says a family trust needs to be documented properly and the trust must keep up to date on loan payments at Canada Revenue Agency's prescribed rate, which is currently 1%. Income earned by investments held in the trust can be flowed through and taxed at lower rates in the hands of the beneficiaries. Because of legal and accounting costs, family trusts are suitable only for high-income earners who can lend large amounts to the trust.

Lend money to your spouse. Loans to spouses can be made at CRA's prescribed interest rate. This strategy enables lower-income spouses to invest and earn income in their own names. Be sure to document the loan properly to avoid the investment income being attributed back to the higher-earning spouse. Crean says that as long as the recipient spouse pays interest by Jan. 30 of the following year, the income will be taxed in his or her hands rather than those of the lending spouse.

Create an individual pension plan. High-income earners who find the RRSP contribution limits insufficient have another retirement-savings alternative: An individual pension plan. Set-up and administration costs are high, but the advantage is being able to make higher tax-deferred contributions than are permitted under the RRSP rules. IPPs, which are customized to the individual's age, income and desired contributions, are worth considering for entrepreneurs, self-employed professionals and senior salaried executives.

Contribute to a spousal RRSP. In this effective income-splitting strategy, the higher-earning spouse to contribute to an RRSP for his or her spouse. The contribution limit is that of the contributing spouse. Caution: If funds are withdrawn from a spousal RRSP, they will be deemed to be taxable income for the contributing spouse if there were any spousal contributions made in the year of withdrawal or the two previous years.

Contribute to a spouse's TFSA. For individuals who are able to maximize their contributions to tax-free savings accounts, the bad news is that the Liberal government is keeping its promise to roll back the annual contribution limit. This year's limit is $5,500, down from $10,000 in 2015. What's still the case, though, is that a higher-income earner can contribute to a spouse's TFSA without any adverse tax consequences. Since no tax liabilities arise from income earned within a TFSA, there is no taxable income to be attributed to the contributing spouse.

Contribute to RESPs. Registered education savings plans offer no immediate tax savings, since contributions are made with after-tax dollars. But income earned within the RESP is taxable in the student's hands, making these plans another form of income-splitting. Better still, there's an opportunity to get up to $7,200 in tax dollars back from the government, through the lifetime limit for the Canada Education Savings Grant.

Be tax-efficient in your asset location. Along with asset allocation, the location of assets between registered and non-registered accounts will affect your after-tax returns. As a general rule, investments that generate fully taxable income -- such as interest income and foreign dividend income -- can benefit from the tax deferral available within RRSPs and other registered accounts. Meanwhile, tax-advantaged investments such as those that pay Canadian corporate dividends or generate capital gains are more suitable for non-registered accounts.

Consider corporate-class funds for tax deferral. Over time, as you near retirement, you're likely to want to dial down your exposure to equities in favour of fixed-income holdings, which are generally less volatile. If your non-registered holdings have gone up in value over time, rebalancing of your asset mix may result in having to pay capital-gains taxes. With mutual funds that are part of a corporate-class structure, you can defer these liabilities. Corporate-class funds enable you to switch between asset classes without triggering a taxable event.

Have the higher-income spouse pay household expenses. In general, says Crean, the higher-income spouse should pay household expenses so that the lower-income spouse can focus on savings as much as possible.

Make a charitable contribution. For wealthy philanthropists, the advantage of the higher tax bracket is that it also applies to the federal tax credit for charitable donations. High-income donors will be able to claim a 33% tax credit on the portion of donations made from income that is subject to the new top tax rate. As before, it's better to pool charitable donations within a family, since the credit for the first $200 in charitable donations is only 15%. Pooling donations makes only a small difference in tax savings. But at a 33% top federal rate, with provincial taxes on top of that, every little bit helps.

	Tax-impact estimates, then and now
		Liberal campaign	Liberal government
	New top tax bracket of 33%	Tax increase of $2.8 billion	Tax increase of $2 billion
	Middle-income tax cut to 20.5%	Tax savings of $2.9 billion	Tax savings of $3.4 billion
	Estimates are for the 2016-17 fiscal year Sources: Liberal Party of Canada platform, 2015; Finance Department estimate on Dec. 7, 2015