The popular image of multimillionaires harboured on yachts while their assets are harboured in offshore tax havens is becoming a relic of the past.
Karen Slezak, a tax partner with Soberman LLP, says governments, including Canada, have become very efficient in closing tax loopholes by keeping tabs on its citizens' world-wide income.
"More and more governments have the ability to share information with each other and electronically track who is involved in which accounts," she says. "I think anybody involved in that type of thing is running out of time."
A perfect example is the recent crackdown on the centuries-old Swiss practice of providing anonymity for banking clients. Last year, the U.S. government forced Switzerland to break its own secrecy laws to prevent the country's biggest bank, UBS, from facing civil litigation in a U.S. court. UBS was forced to hand over information on U.S. clients and pay a $780-million (U.S.) fine. Under threat of further action, Switzerland has agreed to bilateral disclosure deals with the U.S. and other countries, including Germany and Britain.
Ms. Slezak says the noose is also tightening on domestic tax schemes. Tax folklore is filled with stories of breaks available to investors who sink money into ventures such as films or works of art that are bound to fail. "A lot of the new rules around these tax shelters have been significantly tightened up."
Of course, there will be tax cheats as long as there are taxes, but Ms. Slezak says the Canada Revenue Agency has gone on the offensive in an effort to keep Canadians honest. "Ottawa has now introduced legislation where if you're involved in any type of aggressive tax planning, you're supposed to notify [CRA]upfront."
So, what is a multimillionaire to do? Registered Retirement Savings Plan (RRSP) contributions are currently limited to 18 per cent of an individual's previous year's income, up to a maximum of $22,450, and the cap for Tax Free Savings Account (TFSA) contributions is $5,000 annually (inflation adjusted) with the maximum set at $15,000 this year.
Ms. Slezak says that although the idea of investing solely for a tax break is all but dead, there are still plenty of strategies for high-net-worth individuals to lower the tax burden on legitimate investments.
The most basic strategy involves the allocation of assets in and outside of registered accounts like the RRSP and TFSA. In an unregistered account, different investments are taxed differently. Returns from fixed income securities like bonds and money market funds are taxed at 100 per cent.
For individuals in the highest tax bracket, the rate on dividends from eligible Canadian stocks are taxed at roughly 30 per cent and the tax on capital gains generated when the market value of a stock goes up is 23 per cent.
All returns from an RRSP are taxed at 100 per cent when they are eventually withdrawn in the form of a Registered Retirement Income Fund (RRIF), and returns from a TFSA are never taxed.
"You really want to go into more fixed income products in your RRSP and TFSA, and outside of those is where you're going to want to put more of your dividends and stocks," Ms. Slezak recommends.
In an unregistered account, investors can also offset capital gains with capital losses (when a stock goes down in value) from previous years. In addition, investors who borrow money to invest can deduct the interest from their taxable income.
Another strategy involves making your tax plan a family affair by splitting income with family members. TFSAs can be opened up in the name of a spouse or eligible children. It's not that simple with an RRSP, because any contribution made on someone's behalf, such as a spousal RRSP, is deducted from the contributor's limit.
Instead, a loan can be made to a spouse or children in the form of a trust. The lender must charge the minimum prescribed rate, which is currently 1 per cent. By making the loan, anything earned above 1 per cent is legitimately taxed in the hands of the spouse or children – who are presumably in a much lower income bracket. Only the 1 per cent interest is taxable to the lender as income.
This strategy can be used with anyone, but Ms. Slezak suggests family members because the funds legally belong to the recipient – and it's good to have your money in the hands of someone you trust. It also allows the lender to monitor and manage the investments at arm's length. In the case of a trust, the assets are under the control of the parents until the children become adults.
If you want to build up good karma or score points with the man or woman upstairs, donating to religious or charitable organization can lower your taxable income. However, Ms. Slezak advises clients not to expect too many rewards in this life. "You're still typically giving away two dollars to save one, so you better first and foremost want to make the charitable gift," she says. A list of accredited religious and charitable organizations can be found on the Canada Revenue Agency website.
And then there are political contributions. Unlike the United States, the tax credit for contributing to an accredited political party is capped at $1,000. Like the United States, there's no telling how a hefty donation to the right candidate might fit into your tax strategy.