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How to ensure Ottawa gets its share, but no more

If there's a myth that has circulated forever and never seems to lose adherents, it's the assumption that the wealthy don't pay their fair share of taxes.

On the contrary, Canada's high-net-worth individuals are subject to the same income and investment taxes as the rest of the population. But the difference lies in their ability to hire the right people to minimize their tax exposure.

And prepare they do. If the only certainties in life are death and taxes, high-net-worth Canadians often work diligently with their team of accountants, lawyers and financial advisers to plan for both.

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Tom, an angel investor from Ontario who has bought and sold numerous companies over the past 25 years and now spends his time investing his $20-million fortune, says he's saved hundreds of thousands of dollars by taking a methodical approach to tax planning.

When he was busy buying and selling businesses, Tom - who asked that his last name not be used in this article - would take the relatively simple step of establishing holding companies into which the proceeds earned from the sale of one of his firms would flow, thus taxing the earnings at a lower rate.

"We were selling companies worth anywhere from $3-million to $25-million, and I figure I usually saved about 20 per cent in taxes by properly positioning myself from a tax standpoint before completing a sale," he says. Tom credits tax-effective strategies such as this with helping to steadily grow his wealth.

Through careful planning, high-net-worth Canadians can minimize or delay their exposure to costly taxes, thereby maximizing their available capital during their lifetimes. Smart planning can also ensure comfortable inheritances for their family members or upon whomever they choose to bestow their wealth.

But as Tom points out, there's a fine line between tax avoidance and evasion in Canada and it needs to be tread carefully. Otherwise, high-net-worth individuals could find themselves in a very unenviable position - a court battle with the Canada Revenue Agency.

Where to start when preparing a tax-effective strategy? It begins not with discussing taxes specifically, says Bruce Harris, a Toronto-based tax partner at PricewaterhouseCoopers, but rather long-term goals.

"I find that a lot of people haven't figured out what they want to do with the wealth they've built up," Mr. Harris explains. "Once the wish list is figured out, then you can figure out the tax structure to suit those wishes. I'm always hesitant to say, 'This is the specific tax solution a person should look at,' because it depends on what those wishes are."

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Some individuals may choose to leave their fortune or business to their children. But are the kids ready to handle that kind of wealth - or, more importantly, do they want to inherit and continue managing the family business? All these decisions can have a drastic impact on tax planning.

A recent study conducted by Ipsos Reid for BMO Harris Private Banking found that 80 per cent of high-net-worth Canadians plan to leave their estates to their children, but 22 per cent are concerned about their children's ability to manage their new-found wealth. Twenty per cent of those surveyed were unsure how those concerns would affect their strategy.

Once crucial decisions are made on an individual's "wish list," as Mr. Harris calls it, tax strategies must be designed.

According to Michael Cadesky, a partner with Toronto-based tax firm Cadesky and Associates LLP, the needs of an individual who holds investable assets of about $1-million will differ greatly from those who may have $20-million at their disposal.

In the case of the former category, Mr. Cadesky notes that person would usually hold a large portion of wealth in RRSPs, term deposits, stocks and perhaps even a life insurance policy, as well as the equity in their home. Wealthy Canadians in those circumstances, especially if they've come into money, will typically seek to pay off mortgages or other debts, perhaps purchase a second home such as a cottage and create a tax strategy to maximize the benefits of RRSPs.

Mr. Cadesky explains that people in that lower-wealth category should consider spousal loans, where a higher-income-earning family member lends an amount of money to a family member with little or no income (usually a spouse or child) at a prescribed rate, currently 1 per cent. Interest is then paid back to the high-income earner and the money lent to the lower-income earner can then be invested at a rate higher than the 1 per cent paid in interest.

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"We did this for a high-net-worth client last year with $2.5-million," says Jamie Golombek, Toronto-based managing director of tax and estate planning for CIBC Private Wealth Management. "We were able to save thousands of dollars a year in taxes because that spouse had no income. By putting income that otherwise would have been taxed in Ontario at 46.5 per cent into a lower-income spouse's hands at the lowest rate of 21 per cent, you're saving about 25 per cent a year on the investment income."

Depending on the needs of high-net-worth individuals, Mr. Golombek also favours certain trusts - namely testamentary and family trusts - both to minimize taxes in the event of their death and to control how money is spent by heirs, particularly in situations where younger children stand to inherit large estates.

Individuals who own companies, however, should employ other tactics. Where appropriate, Mr. Cadesky often encourages them to form holding companies into which their firm's earnings are diverted and left to sit over time to enjoy the benefits of compounding.

While the individual will eventually pay roughly the full amount of personal tax when the money is withdrawn, the capital will have been allowed to grow substantially over that time.

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