Author Segal LLP

Know the Tax Implications of Dividend Income

lores_investment_folder_file_amIf you are planning to buy shares in a company in the hope of receiving regular dividend payments, take some time to review how the Canada Revenue Agency (CRA) taxes income from directly held shares.

The first step is to realize that your tax bill on dividend income will depend on where the company is located. The CRA treats domestic and foreign dividend income differently.

For a conservative portfolio, you might look for disciplined, well-run, profitable companies that have a record of regularly boosting their payouts.

You can find blue-chip stocks that provide yields competitive with short-term bonds and Guaranteed Investment Contracts.

But remember, companies can cut their dividend outlays for any number of reasons and that can cause the stock’s price to slide.

Domestic Dividend Income: If you own shares in a taxable Canadian corporation, you are eligible to take a dividend tax credit aimed at preventing double taxation. Dividends are paid out of a company’s after-tax earnings, which means that when you get your payout, the company has already paid taxes on it.

Foreign Dividend Income: Taxation is more complicated when you receive dividends from a foreign company, although you may be eligible for a foreign tax credit. The tax due on foreign income is based on treaties between Canada and the countries where the companies are domiciled. Generally, Canadians will pay tax on foreign dividend income in Canada and get credit for foreign taxes withheld.

More than 750,000 Canadians hold U.S. investments directly or through a registered account. American companies generally withhold taxes on your dividend payments but the exact amount depends on whether you certify that you are a Canadian resident. When your Canadian tax return is prepared, you may receive a foreign tax credit.

The tax credits for Canadian dividends make them a very tax-efficient source of income for most Canadian investors.

Taxation of dividend income can be complicated and it’s best to consult with your tax adviser, who can ensure you pay the least amount of tax possible.

Foil Fraud at Your Enterprise

thmb_hr_practices_hand_cookie_jar_savings_petty_cash_take_amMonitor, Verify and Verify Again

Over the past decade or so, well-publicized scandals involving Enron, Parmalat, Royal Ahold, WorldCom and other companies have prompted corporate officials, lawmakers and regulators to insist on beefing up internal auditing controls and risk-management operations.

Asset Misappropriation in Canada  

Ninety per cent of occupational fraud cases in Canada involve asset misappropriations, according to a study by the Association of Certified Fraud Examiners.
Those misappropriations had a median loss of $200,000; 38.9 per cent had a corruption component with a median loss of $250,000; 11.1 per cent involved fraudulent financial statement schemes with a median loss of $1,075,000.

Cash is by far the most frequently misappropriated asset, accounting for 86.4 per cent with a median loss of $198,500. That loss is nearly double the non-cash losses, which totaled a median $100,000.

This finding is most likely explained by the liquid nature of cash as opposed to inventory, equipment and other non-cash assets, according to the study, entitled Detecting Occupational Fraud in Canada.

And yet, fraud still occurs at companies, despite spending multi-millions of dollars on software and hiring multitudes of risk monitors, auditors and compliance personnel. While you may not want to budget large sums on risk-management, there are some fundamental tools that should never be ignored by any business of any size in any industry. At the top of the list is the most critical canon of forensic accounting:

Every employee must take some annual leave. While employees are on holiday, a co-worker should cover for them. This is a simple step, but it has uncovered many sophisticated frauds and embezzlements.

Employees who process transactions should be taken off their desks at intervals, so that any existing chain of successive falsifications can be discovered and broken. Refusing vacation time is one of a series of behaviours that should be considered suspicious if they arise in conjunction with fiduciary abnormalities. Watch for sudden changes in lifestyle, or buying a larger home, a more expensive car or costly clothing.

Here are five other steps to take to help ensure your business is protected from employee fraud:

1. Update and modify controls: Successful businesses grow and expand, and in the process their internal controls can become outdated or overworked. Be sure to review your company’s controls on a regular basis to help ensure that they are still adequate.

2. Set up checks and balances: Your company doesn’t have to be a world-class financial institution to have complex transactions that can involve several reports rather than a single document accounting for all aspects of the deal. Be certain that your company enforces disciplined reporting of facts and information and reviews them from all angles. Make sure all relevant parties — traders, accountants, risk managers and the people who run the business — regularly and rigorously review everything. And, perhaps most importantly, check reports randomly rather than on a regular schedule.

3. Vigilantly monitor internal controls: Part of monitoring controls should involve periodic testing to see how easily your company’s systems and procedures can be penetrated. And when designing security systems, always assume that every user has the potential to be a criminal. A trusted insider who learns the inner workings of the company network, security specialists warn, can do some of the worst damage.

4. Frequently review passwords:
 Make staff aware of the importance of keeping passwords confidential and secure. Limit employee access to information, and require use of passwords that are not easily guessed. Some forensic specialists recommend changing passwords at least every 30 days. Regularly audit systems that don’t require passwords.

5. Trust no one: While you don’t want to run your business like a prison, never assume that because an employee is performing “junior” work that there is no chance for fraud. When you are confronted with questions about any employee’s suspicious behaviour, take action immediately and double check what you discover. Verify everything. People tend to ignore suspicious activity, rationalize decisions to not take action, or misguidedly think that no single individual is in a position to create any damage.

Resolve the Deal Breaker

lores_handshake_agreement_deal_reach_blue_MBDisagreements over a business’s valuation aren’t uncommon.

If, for example, you want to sell your business, you may feel it is undervalued because of market conditions, so ou want to factor into your asking price the company’s future performance. A buyer may come along, however, who isn’t so sure that those future projections will be realized and hesitates when it comes to closing the sale.

That disagreement doesn’t have to be a deal breaker. You can bridge the gap of the two valuations by arranging an earn-out agreement, where you receive a partial payment with future specified amounts paid when the business meets certain goals.

For example: You set a sale price of $1 million based on projected sales for next year. The buyer feels those sales projections aren’t guaranteed. So you agree to take $500,000 on the spot and the remainder is paid out of, or adjusted to reflect, the income your business actually earns based on those projections.

You both benefit: The buyer gains an additional source of financing while minimizing risks and costs and you get to share in future earnings and, because the deal isn’t simply an installment plan, you gain some tax benefits. 

But the agreement needs to be structured properly and address several issues, including:  

  • Duration: Earn-outs can typically run as long as five years. However, the longer the term the more difficult it can be to attribute performance to the business alone. On the other hand, you may face resistance to a short term if the buyer is concerned that a shorter duration could encourage you to make business decisions that favor short-term results but damage the long-term viability of the business. Moreover, to be able to get the benefits of using the cost recovery method when you pay your taxes, the Canada Revenue Agency (CRA) insists that the agreement last no longer than five years.
  • Authority: You may want to draft an employment contract that specifies who has ultimate control over management and strategy. As the seller, you may want to retain control over operations to help ensure performance goals are met, over the sale or purchase of additional assets, and over the hiring of key staff members. Pay particular attention to the duration of the contract: the buyer may not be willing to maintain an employee role once the earn-out is paid.
  • Performance goals: The agreement should outline such clear and achievable performance goals as sales, pre-tax earnings or gross profit as well as non-financial goals such as product or account development, capacity utilization, or service improvements.
  • Performance evaluations: Clearly define the measurement base and be sure it is monitored. If the base is pre-tax earnings, you should ensure that the agreement specifies how one-time costs, unexpected costs, new management costs, transfer pricing and other costs or windfalls will be treated. Periodic audits can ensure that systems and operations aren’t manipulated to artificially boost or suppress performance measures.

Last Word: Any of these issues create the risk of litigation, so you should choose some method to resolve disputes and avoid litigation.

CRA Aims to Boost Services for Small and Medium-Sized Businesses

071417_Thinkstock_521090040_lores_kwSmall- and medium-sized businesses will be getting more help from Canada Revenue Agency (CRA) over the next couple of years.

The tax agency recently unveiled plans to make its services for those businesses more helpful and easier to use. The new plan follows consultations started in October 2016 and follows separate consultations in 2012 and 2014. The agency met with businesses, accountants and CRA employees who regularly interact with businesses, and also accepted feedback online and discussed issues with business associations.

“The vast majority of Canadians do everything right.”

— A CRA employee

The result is a program called Serving You Better. The CRA received more than 1,500 comments and suggestions. Here is a summary of the new initiative taken from the CRA website:

Making Tax Information Easier to Access, Understand and Use

Participants told the CRA they don’t like busy signals when they call and they do like services with a call-back option. Accountants want to ask complex questions on the phone. Businesses would like an auto-fill option and to be able to complete more tasks online.

The CRA said it will:

  • Switch over to the Government’s telephone platform and complete feasibility studies for adding call-back and secure chat lines.
  • Conduct a pilot for a service dedicated to letting tax preparers call experienced CRA staff members who can help with complex technical issues.
  • Review the Pensionable Insurable Earnings Report (PIER) and other notices and letters for businesses. Let corporations see the assessed value of income tax returns and schedules as well as their CRA-verified dividend account balances in My Business Account.
  • Expand the Liaison Officer Assistance Requests pilot program to allow businesses across Canada to request a Liaison Officer visit. Start an auto-fill option using commercial software.
  • Study the possibility of setting up a volunteer tax program that would help the smallest new businesses understand the payroll, GST/HST and other tax obligations that come with starting a business.
“My clients and I are frustrated that we aren’t able to obtain remittance forms online.”

— An accountant

Clarifying Information about Payment Options

Participants noted that payments don’t always go where they expect. Although there have been improvements, individuals said they still had concerns about these errors and the time it takes to resolve them.

The CRA said it will:

  • Improve the way it explains how to fix misallocated payments when and where taxpayers want.
  • Raise awareness about direct deposits into taxpayers’ bank accounts.
  • Make payroll remittance vouchers easier to order online.
  • Explain clearly how remittance vouchers are personalized to ensure payments go to the right accounts.
“Objections are a nightmare just to get assigned.”

— From an accountant

 Improving Services Related to Audits, Collections and Appeals

Taxpayers and accountants were clear about how unhappy they are with the amount of time it takes to resolve any objections. They want better communications between their businesses and representatives and CRA auditors.

The CRA said it will:

  • Improve the time it takes to resolve an objection (it developed a plan to improve timeliness and better inform Canadians of the expected and actual time frames for resolving an objection based on its complexity.
  • Improve audit processes and communications through a post-audit survey and by monitoring the feedback it receives.
  • Enhance the clearance certificate process by communicating earlier when you apply and by helping businesses identify situations when a certificate isn’t required.
  • Ensure consistency by communicating collection procedures to audit branches and offering training for auditors.

The CRA notes that it has previous consultations on cutting red tape in 2012 and 2014. As a result, the tax agency says it already has:

1. Introduced the Liaison Officer initiative.

2. Engaged associations including the Canadian Payroll Association and the Chartered Professional Accountants of Canada (CPA Canada) to identify CRA guides and forms needing to be simplified and clarified.

3. Reduced the payroll remittance burden for the smallest new employers.

4. Allowed businesses to request a payment search using the My Business Account Enquiries Service and to submit cashed cheques as proof of payment using Submit Documents.

5. Included a My Audit tab in My Business Account that allows electronic communications between businesses and auditors.

6. Provided a streamlined Interactive Voice Response system that makes it easier for business callers to connect with an agent.

7. Introduced training to help auditors become more sensitive to the needs and realities of small and medium businesses.

8. Reviewed completely its notices and letters to make them clearer and easier to understand.

9. Reduced the need for callers to repeat information when a call is transferred from one agent to another.

10. Set up a way to connect callers to the right expert.

Top 10 Things You’ll Be Able to Do

The CRA’s 2017-2019 Serving You Better action plan contains over 50 action items that the agency expects will improve services for small and medium businesses.

According to the CRA, here are the top 10 things you’ll be able to do:

1. Receive a CRA security code by email

2. Call a new dedicated telephone service for tax preparers that helps with more complex technical issues

3. Request a Liaison Officer visit

4. Provide T4 information slips to your employees in electronic format (certain conditions apply)

5. Use T2 Auto-fill through commercial software

6. Create your own filing and balance confirmation letters online

7. View short “how-to” videos that explain the services on My Business Account

8. Experience telephone service improvements

9. Share feedback about your audit experience in a new post-audit survey

10. Have your objections resolved faster

Canada: Fifth Most Millionaire Households Yet Many Are Buried in Debt

070717_Thinkstock_452678211_lores_kwCanada moved up to fifth place from eighth of countries with the most millionaire households in 2016, according to a recently published report by Boston Consulting Group (BCG).

And yet, the Bank for International Settlements (BIS), Bank of Canada and other organizations have recently expressed concern about the country’s debt problems.

Warnings About Debt

The BIS, which serves as a bank for central banks, is flashing warning signals that mean Canadian debt has reached critical levels, and will likely result in a financial crisis. The BIS notes that the gap between credit consumption and economic output (gross domestic product) has reached a critical 14.1 level in Canada.

That gap measures the risk associated with the credit given to households and businesses in a country. The BIS considers anything above 2 to be a strong gap, and anything above 10 to be a critical warning. Breaching 10 results in a banking crisis in two-thirds of economies within three years.

More locally, the Bank of Canada recently warned that Canada’s financial system is becoming increasingly exposed to economic shocks as household debt levels continue to climb and major housing markets remain hot. The central bank noted that highly indebted households have less flexibility to deal with sudden changes in their income.

“As the number of these households grows, it is more likely that adverse economic shocks to households would significantly affect the economy and the financial system,” the bank said.

And while it seemed Canadians were ignoring its warnings about high household debt, the central bank posted a video on YouTube explaining how the dangerous combination of debt and inflated house prices could lead to recession or worse.

Statistics Canada also recently confirmed that many Canadians are drowning in debt. The agency said Canadians owed $1.67 in consumer credit, mortgages and non-mortgage loans for every dollar of household disposable income in the first quarter of 2017. That was a slight quarterly decrease as household net worth rose from the end of 2016.

It’s interesting to note that despite the high debt levels, most Canadians don’t appear to be defaulting. Credit agency TransUnion says that the 90-plus day non-mortgage account delinquency rate in the first quarter of 2017 dropped to 2.72%, down nearly 1.5% from the year before.

Back to the Wealthy

Meanwhile, Canada’s richest households control an ever-growing share of the country’s wealth. According to the Fraser Institute, a nonpartisan research and educational organization, the top 20% of Canadians own about 67% of the country’s wealth and the bottom 20% own none. But what accounts for this inequality? Not necessarily hard work or large inheritances.

“A deeper understanding of the statistics reveals the vast majority of wealth inequality in Canada is simply due to differences in people’s age and the fact that people accumulate more wealth as they get older. In other words, wealth inequality is largely a fact of life,” the Fraser Institute says.

Meaning that the wealth gap in Canada is explained by people’s stage in life.

But that doesn’t help if you’re saddled with debt, whether you make more than $500,000 a year or less than $30,000. What can you do about it? Here are a few suggestions.

Getting Out of Debt

The first step is to calculate your debt situation. Your financial advisor can help with this. One way is to find your debt-to-asset ratio. This measures what you owe (liabilities) to what you own (assets). Add up your mortgage, car loan, lines of credit, credit card debt and anything else you owe. Then tally your total assets, including the appraised value of your home, savings and investments including Registered Retirement Savings Plans and Tax Free Savings Accounts, and any other property that’ll grow or retain its value.

Divide your debts by your assets and multiply by 100. You want a low ratio. For example, if you owe $300,000 and have $75,000 in assets, your ratio is 400%. But if you owe $75,000 and have $300,000 in assets, the number is a much smaller 25%.

Then, regardless of how much you earn, consider these ways to control your spending, manage debts wisely and, if necessary, reduce your liabilities:

Create or review a budget. This will help you figure out how much money you take in, spend and save. It’ll also help you balance your income and regular expenses as well as guide you toward your financial goals.

Organize. Take stock over everything you’re spending money on each week. Keep receipts in order to help you get a handle on where your money is going. Pay yourself first, through auto-deposits into savings accounts or retirement/pension plans.

Distinguish between want and need. This can help you reduce expenses for what might be frivolous things such as a sports car you’ve been eyeing, extra cable channels or that big-screen 4K television set. Make spending choices based on what you need — not what the TV ads or signs in shop windows say you need.

Review your automatic payments. You may be paying for things you no long use, such as club or gym memberships, newspapers or magazines. Stop these immediately.

Shop for bargains. You can usually find ways to cut costs, whether it’s the kids’ clothes, dental checkups, car wash, books you could get at the library instead of purchasing them or bulk food instead of expensive premium brand food.

Avoid late fees. Save yourself extra fees and expenses by paying bills before they’re due or set up auto-payments at your bank for what you actually use.

Decide which debts to pay off first. By paying off the balances with the highest interest first, you’ll pay less interest. This will help you become debt-free sooner. List your debts in order from the highest interest rate to the lowest. Make the minimum payments on all your debts. Then, use any extra money to pay down the highest interest debt.

You may want to start with your debt with the lowest balance. You may feel an accomplishment by paying off a debt. This can keep you motivated to maintain your goal of becoming debt-free. However, this option may cost you more in interest over time.

Work with your creditors. Contact creditors to discuss your financial situation. They may offer such solutions as:

  • Lowering the interest rate on your debt,
  • Extending payments over a longer period of time, or
  • Reducing your minimum monthly payment.

Close accounts that are paid. Once you pay off a debt, consider closing it. One account with a low credit limit can be useful to maintain or improve your credit score. Keep only what you need and can manage responsibly. You may also want to consider using a secured credit card instead of a regular credit card. A secured credit card requires you to leave a deposit with the credit card issuer as a guarantee.

Lose the credit cards. There’s no easier or faster way for you to increase debt than using credit cards. Something about charging purchases makes many people think they aren’t increasing their debt. The best way to dispel this illusion and get your spending and debt under control may be to cut up credit cards.

Consolidate debts. If you have high-interest loans, consider taking out a single loan with a lower interest rate to consolidate your debt. This will mean you’ll only have to make one payment.

A consolidation loan may help you get out of debt, if it:

  • Has a lower interest rate than all your other debts put together, and
  • Has a lower monthly payment than all your other debts put together.

But be careful to not to use the credit that is freed up. If you can increase your payments on the consolidation loan, you’ll reduce your debt faster and pay less in interest. A consolidation loan won’t hurt your credit rating if you make the payments on time.

Consult with your financial advisor for more ways to manage your debt and build your net worth.