Skyline Wealth Management and RLB talk about private investing and taxation

Private Investing and Taxation ft. RLB


Private investments have gained significant momentum in the last few years, and there are some common questions that our investors have been asking us. Ray Punn, Vice-President of Skyline Wealth Management, sat down with Shawn Deyell, Chartered Professional Accountant from RLB LLP, to answer some of our investor questions regarding private investing and taxation in Canada.

Shawn Deyell has been with RLB since 2006 and specializes in Tax Advisory services. Shawn’s problem-solving skills and expertise in trust and estate planning services have helped his clients succeed and grow beyond themselves.

Interview Transcript – Private Investing and Taxation

Ray: Thanks for talking with us today Shawn and answering some of the questions our investors are coming to us with. One of the most common questions is about return of capital (ROC) distributions. How can you best describe what ROC is? What are some other common investment distribution types?

Shawn: Happy to be able to provide some insight, Ray. Return of Capital, or ROC, is a distribution that returns a portion of the original investment. It is generally tax-free at the time of distribution but reduces the adjusted cost base (ACB) of the investment, impacting treatment on sale or redemption.

Another common distribution is other income, which is taxable to the investor based on their applicable tax rates. Capital gains are another common distribution type that is also taxable but at half-rates compared to other income.

Ray: Talking about taxes, how are private investments taxed at redemptions? Could you explain specifically how Skyline REITs are taxed?

Shawn: Skyline REIT unit redemptions result in a capital gain for investors. The capital gain is the difference between the redemption price (how much was received for the units redeemed) and the ACB of those units. ACB is the original purchase price for the units less any ROC while the units have been owned. Where the investor purchased units at different times for different prices, the ACB would be the average of purchase prices and ROC. Also, where an investor redeems only a portion of units, the same portion of their ACB would be considered for the gain. For example, an investor redeeming 40% of their units in a REIT would apply 40% of their total ACB on units of that same REIT.

Ray: So, that means investors can have potential tax benefits depending upon when they choose to redeem. What are some common missteps investors make with tax planning and making investments?

Shawn: Investors commonly ignore the tax treatment for investments when considering their returns. Distribution types with preferred tax treatment or ones that allow for tax deferral can be powerful for growing investments and maximizing after-tax returns. An investment that provides value growth, capital gains returns or ROC may result in a much better overall after-tax return compared to investments providing only interest or other income distributions, even if they have a higher pre-tax percentage return.

Failing to match investments to cash flow needs can also be ineffective for investors and trigger costly tax and investment results. For investors requiring cash flow, selling or redeeming investments to provide cash flow can trigger tax and may not maximize the investment growth potential that could result from better timing of investment sale or redemption. Investments providing regular distributions, especially ROC, could benefit investors through meeting cash flow needs and providing tax deferral. Conversely, investors who do not require short-term cash flow may benefit from investments with greater growth potential rather than distributions or setting up those investments for a distribution reinvestment plan (DRIP) to convert any distribution into more investment ownership.

Ray: One could say private investments may provide options based on the investor’s cash flow requirements. So, when does owning investments in a holding company make sense?

Shawn: A holding company to own investments can be a compelling tool, provided the benefits outweigh the costs. A holding company can provide some tax deferral as corporate tax rates may be lower than personal tax rates, with the difference in tax effectively being payable when funds are withdrawn from the holding company. Another benefit may be personal income tax savings, where better control of timing payments from the holding company to its owners could allow access to lower marginal tax rates. A holding company may also provide flexibility and savings with respect to estate taxes.

The creation and maintenance of a holding company would have both setup and ongoing costs and administration work that should be considered. Investors with an existing company may benefit from using it as an investment holding company but should consider risk exposure and potential loss of tax benefits. In particular, special care should be taken where active business operations or higher-risk activities are conducted in that existing company or a subsidiary of that company. Personally held investments may be transferred to a holding company without triggering taxes until eventually sold or redeemed in the company.

Ray: So, this means a holding company may be potentially beneficial but could have added costs and increased risk exposure. Other than TFSA or RRSP contributions, are there other strategies investors can leverage to further tax benefits?

Shawn: Investors may benefit from lower personal tax brackets by spreading investment sales or redemptions over multiple years or by timing such sales or redemptions in a year with lower-than-normal income. Spreading investment ownership, and thus any resulting taxable distributions and gains between spouses or among other family members, may also provide significant advantages by using lower personal tax brackets. This strategy is often referred to as ‘income splitting,’ and tax rules can be complex in determining when advantages are available or not, so addressing your specific situation with a tax advisor would be needed in this type of planning.

Investors may also sell investments with large gains during the same year as selling investments with losses. This could allow the gains to be offset by the losses and reduce or eliminate tax accordingly. Investors should beware of restrictions on repurchasing investments on which losses were triggered within a short timeframe as it may not allow the losses to be used for offsetting gains.

Should investors want to make charitable donations, there could be substantial tax advantages to donating certain investments, including Skyline REIT units, rather than cash donations. Where qualifying investments are donated, the investor would be allowed a donation tax credit based on the full value of the investment with any gains on the investment being tax-free. As an example, based on a 50% tax rate for an investor, charitable donations of qualifying investments worth $10,000 with an ACB of $6,000 could provide $5,000 tax savings from donations while also saving $1,000 tax that would otherwise be triggered on the gains. A win for the investor and the charity!

Ray: It is great to be able to leverage tax benefits while also giving back to the community. Thank you, Shawn, for taking the time to share some advice on how to optimize investment benefits with our readers today. We look forward to continuing this conversation and look forward to the next instalment of this three-part series with you.

If you are interested to learn more about private investments, connect with a Skyline Wealth Management Advisor today to discuss your investment goals.

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