My name is Mark Goodfield. Welcome to The Blunt Bean Counter ™, a blog that shares my thoughts on income taxes, finance and the psychology of money. I am a Chartered Professional Accountant and a partner with a National Accounting Firm in Toronto. This blog is meant for everyone, but in particular for high net worth individuals and owners of private corporations. The views and opinions expressed in this blog are written solely in my personal capacity and cannot be attributed to the accounting firm with which I am affiliated. My posts are blunt, opinionated and even have a twist of humor/sarcasm. You've been warned.

Tuesday, March 29, 2011

2011 Ontario Non- Budget: Yawn Part Deux

If the 2011 Federal budget was a yawn from an income tax measure perspective, then the Ontario budget could be considered the Federal budget on Sominex.

The Ontario Minister of Finance, Dwight Duncan, today presented the Ontario Budget. For those who wish to read my firm’s (Cunningham LLP) summary, unfortunately, there is not one. My firm decided it was not worth the effort, since there is absolutely nothing in the budget.

As an aside, whether you are a Liberal supporter or not, has there ever been a premier that has left less of an impression over eight or so years than Dalton McGuinty?

I guess Ontario is just running on all cylinders and thus there was no need for any income tax measures to improve the provinces performance. Trying to be even handed, some may say McGuinty is in a catch-22 situation. The Federal Liberals are in the middle of an election and are publicly against any more tax cuts, so how could he, as a Liberal, make any tax cuts in Ontario? On the other hand, he can’t increase tax rates because he is facing an election in October of this year and is seeking a third term.

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs.

Your House is your Castle

I have written a guest blog entitled Your principle residence is tax exempt for Jim Yih on his Retire Happy Blog.

The blog is about claiming your principal residence exemption and what is required if you turn your principal residence into a rental property.

Thanks to Jim for providing a forum for my three guest posts; Big Brother (Canada Revenue Agency) is Watching, Tax Tips from a Blunt Bean Counter and the above blog on principal residences.

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs.

Monday, March 28, 2011

Personal Use Property - Taxable even if the Picasso Walks Out the Door

I will start today’s blog with a question. What do stamps, duck decoys, hockey cards, dolls, coins, comics, art, books, toys and lamps have in common?

If you answered that the collection of these items are hobbies, you are partially correct. What you may not know is, that these hobbies also generate some of the most valuable collectibles in the world.

When a collector dies and leaves these types of collectibles to the next generation, the collectibles can cause rifts amongst family members. The rifts may occur in regard to which child is entitled to ownership of which collectible and whether the income tax liability related to these collectibles should be reported by the family members.

Let’s examine these issues one at a time. Many of these collectibles somehow miss being included in wills. I think the reason for this is two-fold. The first reason is that some parents truly do not recognize the value of some of these collectibles, and the second more likely reason is, that they do realize the value and they don't want these assets to come to the attention of the tax authorities by including them in their will (a third potential reason is that your parents frequented disco's in the 70's and they took Gloria Gaynor singing "Walk out the Door" literally- but I digress and I am showing my age).

Two issues arise when collectibles are ignored in wills:
  1. The parents take a huge leap of faith that their children will sort out the ownership of these assets in a detached and non-emotional manner, which is very unlikely, especially if the collectibles have wide ranging values; and
  2. The collectibles in many cases will trigger an income tax liability if the deceased was the last surviving spouse or the collectibles were not left to a surviving spouse. 
Collectibles are considered personal-use property. Personal-use property is divided into two sub-categories, one being listed personal property (“LPP”), the category most of the above collectibles fall into, and the other category being regular personal-use property (“PUP”).

PUP refers to items that are owned primarily for the personal use or enjoyment by your family and yourself. It includes all personal and household items, such as furniture, automobiles, boats, a cottage, and other similar properties. These type properties, other than the cottage or certain types of antiques and collectibles (e.g. classic automobiles), typically decline in value. You cannot claim a capital loss on PUP.

For PUP,  where the proceeds received when you sell the item are less than $1,000 (or if the market value of the item is less than $1,000 if your parent passes away) there is no capital gain or loss. Where the proceeds of disposition are greater than $1,000 (or the market value at the date a parent passes away is greater than $1,000) there maybe a capital gain. Where the proceeds are greater than $1,000 (or the market value greater than $1,000 when a parent passes away), the adjusted cost base (“ACB”) will be deemed to be the greater of $1,000 or the actual ACB (i.e. generally the amount originally paid) in determining any capital gain that must be reported. Thus, the Canada Revenue Agency essentially provides you with a minimum ACB of $1,000.

LPP typically increases in value over time. LPP includes all or any part of any interest in or any right to the following properties:

  1. prints, etchings, drawings, paintings, sculptures, or other similar works of art; 
  2. jewellery; 
  3. rare folios, rare manuscripts, or rare books; 
  4. stamps; and 
  5. coins. 
Capital gains on LPP are calculated in the same manner as capital gains on PUP. Capital losses on LPP where the ACB exceeds the $1,000 minimum noted above, may be applied against future LPP capital gains, although as noted above, these type items tend to increase in value.

The taxation of collectibles becomes especially interesting upon the death of the last spouse to die. There is a deemed disposition of the asset at death. For example, if your parents were lucky or smart enough to have purchased art from a member of the Group of Seven many years ago for say $2,000 and the art is now worth $50,000, there would be a capital gain of $48,000 upon the death of the last spouse (assuming the art had been transferred to that spouse upon the death of the first spouse). That deemed capital gain has to be reported on the terminal income tax return of the last surviving spouse. The income tax on that gain could be as high as $11,000.

The above noted tax liability is why some families decide to let the collectibles “Walk out the Door.” However, by allowing the collectibles to walk, family members who are executors can potentially be held liable for any income tax not reported by the estate and thus, should tread carefully in distributing assets such as collectibles. (As an aside, starting next week, I will begin a three part series on executors).

If you are an avid collector, it may make sense to have the collectibles initially purchased in a child’s name. You should speak to a tax professional before considering such, as you need to be careful in navigating the income attribution tax rules.

Where the above alternative is not practical or desirable, you should ensure that you have set aside funds or even taken out life insurance in order to cover the income tax liability stemming from these collectibles that may arise upon your death.

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs.

Friday, March 25, 2011

Confessions of a Tax Accountant-Week 4-Tracking the ACB of your Securities and Income Trust Units

Just to change it up this week, instead of blaming the March 31st issuance of T3’s and T5013’s for the fact that as of today I still have only received approximately 22% of my client’s income tax returns; I will blame last weeks March break, and the fact clients were too preoccupied with their families to worry about submitting their income tax returns.

During the past week, two issues arose that I would like to discuss in more detail.

Tracking your Adjusted Cost Base

This week, one of my staff members emailed me that he could not complete a client’s tax return because he was missing the adjusted cost base (“ACB”) on several of my clients stock dispositions during the year. He advised me that the underlying issue was that the client had transferred brokers twice over the last few years and consequently, the client, not to mention the brokers, have lost track of the original ACB on several stocks.

This email raises two issues:

  1. There is no consistency amongst the various Canadian brokerages in regard to tracking clients ACB's in their trading and margin accounts. A few institutions attempt to track their clients ACB's, but most just provide the current stock price and no historical cost base information.
  2. Once securities have been moved amongst brokerages; for those institutions that actually attempt to track the ACB, it is a total "crap shoot" whether the monthly statements from your new broker will reflect an accurate ACB .
It is thus imperative, that you maintain the original acquisition costs of all security purchases. Since every brokerage firm in Canada provides a yearly transaction summary, all you have to do is keep that one yearly capital transaction summary in a file. If you can manage this small filing task, you will have a historical ACB for all your stock purchases; really not an arduous task.

I have not even broached the topic of foreign holdings, for which the tracking of the ACB is a nightmare in most cases. In the few circumstances brokers even consider tracking such, often the wrong exchange rate is used, or worse yet, the brokerage converts the initial cost at the same rate as the current years sale.

A related issue that arose this week is the tracking of the ACB for income trusts units. Where you own an income trust unit (this issue will diminish going forward as many income trusts have converted to corporations) you receive a T3 and box 42 of the T3 denotes the return of capital (“ROC”) you have received each year from the income trust. In order to determine the proper ACB of a trust unit sold or alternatively, converted to a corporate share (the old ACB of your trust share in most cases will be your new ACB for the corporate share, as most conversions were done on a tax deferred rollover basis) you must reduce what you actually paid for the trust units by the ROC reported in box 42 each year. Many clients do not track the historical return of capital (luckily in many cases they can be found on the Internet) or even know when they purchased the units initially (which is problematic even when you can find the ROC for prior years).

So the moral of the ACB story is; a little record keeping goes a long way.

[Bloggers Note: In my Confessions of a Tax Accountant blogs, I will discuss real income tax issues that arise, but embellish or slightly change facts to protect the innocent, as the saying goes.]

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs.

Tuesday, March 22, 2011

2011 Federal Budget- "Yawn"- What Should have been Considered

The Minister of Finance, Jim Flaherty, today presented the Federal Budget. For those who wish to read my firm’s (Cunningham LLP) summary of the 2011 budget, please click the preceding link.

In order that there is no confusion, given the link to my firm above, the following are my comments and views and they do not necessarily reflect those of my firm.

In my opinion, this was a nothing budget, with piddling income tax credits and an over abundance of anti-avoidance measures. Most likely given the political climate, much of what was proposed today may never see the light of day. I will comment on a couple items of interest, but I do not feel like rehashing this budget; if a rehash is what you desire, there are multiple media outlets where you can read such.

There were only two items I found of interest and that is because I am a tax accountant. I would suggest, most readers will not be intrigued by either of these two items.

1. The proposal to restrict the donation of flow-through shares from the exemption from capital gains tax is interesting to me, since it has been part of the "packaging" by those who sell these investments; buy the flow-through, get a 100% write-off, then either sell the shares to utilize prior capital losses or donate the shares and obtain a donation.

2. The proposal to eliminate the partnership deferral will impact certain clients of mine. Often a partnership would be established with say a May 31st year end, while the corporate partner(s) would have say an April 30th year end. So, for example, the partnerships May 31, 2010 income would not be taxed and picked up by the corporate partners until their April 30, 2011 year-end, resulting in a deferral of almost a year. This proposed change is similar to the phase-out several years ago of the tax deferral for those of you who were self-employed with off-calender year-ends.

So, what do I think middle and higher income tax bracket taxpayers and entrepreneurs who own their own private corporations would have liked to have seen in today's budget?

How about any of the following: 
  • Allowing child care expenses to be deducted by either parent (currently only deductible by the lower wage earner)
  • Expanding the $750,000 capital gains exemption to include the sale of assets where greater than 90% of the business is sold (many purchasers will not purchase shares for liability reasons and thus, many small business owners cannot access the $750,000 exemption)
  • Providing a second $750,000 capital gains exemption for any business owner who sells one business and starts a second and at the time of the sale of the second business has a minimum of say 20 employees
  • Increase in the small business deduction limit to $600,000 (currently $500,000), or a reduction in the corporate tax rate on the first $500,000 of taxable income to encourage job creation
  • Changes to the minimum RRIF withdrawal rules
  • An increase in the RRSP contribution limit
  • An increase in the TFSA contribution limit
  • Reduction in personal taxes rates
  • And going for the gusto, a $100,000 exemption in addition to the principal residence exemption to be applied against the capital gains of second properties, be it your city home or cottage
And, yes, I am seeing a doctor for my delusional thoughts :)

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs.

Monday, March 21, 2011

Reading Financial Statements For Dummies

Today I will discuss some simple tips to utilize when reading financial statements (that clicking sound you just heard are the other readers hitting the escape button when they saw reading and financial statements used in the same sentence). For the two of you still here,"Dummies" is of course used in the popular culture context; however, in the case of reading financial statements, I often feel like one and I am an accountant.
If you are a non-accountant, what should you look for when reviewing a company’s financial statements? I will assume you do not have the background to review such technical items as the accounting policies to determine how revenue is recognized or such; so here are a few simple things non-accountants can look for in the financials:

1. Cash is always king, so always include a review of the statement of cash flows, especially in the case of mature companies. None other then Warren Buffett says "it’s good to compare how much different cash flow is from net income: if the latter is substantially higher than the former, you could have some aggressive accounting to worry about" (see Larry MacDonald's blog Buffet on accounting manipulation for further Buffett comments).

2. For those with a sense of accounting adventure, you can try and calculate the Current Ratio and Debt Ratio:
The current ratio measures liquidity, (a sense of a company's ability to meet its short-term liabilities with liquid assets) and is calculated by dividing Current Assets by Current Liabilities. A ratio of 1:1 implies adequate coverage and the higher above 1:1 the better. If it is relatively low and declining, that is not a good sign.
A company's debt ratio is calculated by dividing Total Liabilities by Total Assets (or alternatively, Total debt divided by Total Assets). This ratio tells you the extent by which a company’s assets have been financed with debt. For example, a debt ratio of 40% indicates that 40% of the company's assets have been financed with borrowed funds. Debt can be good or bad. In times of economic stress or rising interest rates, companies with high debt ratios can experience financial problems. During good times, debt can enhance profitability by financing growth at a lower cost.

3. If you have always wished for a "Coles Notes" summary of the financial statements you are in luck. Effective for all periods ending on or after December 15, 2010 new audit standards in Canada will result in changes to the auditor’s report, which will make it far simpler for investors of any sophistication to determine the key issues in the statements. One major change is the requirement for an “Emphasis of Matter” paragraph in the auditor's report. Companies will now be required to highlight matters that are disclosed in the financial statements that are of such importance, they are fundamental to the users’ understanding of the financial statements. The issues noted in the Emphasis of Matter discussion are disclosed elsewhere in the financial statement notes, but the new paragraph prevents companies from being able to hide these issues in the many pages of notes.

4. The notes to the financial statements are ignored by many novice investors, but the notes often have important nuggets of information. One of the first notes on any set of financials are the accounting policies and accounting estimates notes. For most non accountants, trying to follow and understand the accounting policies and estimates will be futile, however, if these notes disclose a change, try your best to understand the impact of the change on the F/S which should be disclosed in the case of a change in policy. You should also always read the “Subsequent Events” note to determine if anything of a substantial nature has changed for the company that is not reflected in the financial statements. The commitments note will inform you of any required outlays over the next several years and finally the contingency note, which will inform you of potential lawsuits and such. Some of these items may not be disclosed in the Emphasis of Matters note discussed in #3 above.

5. Most public company financial statements reveal how many fully diluted shares are outstanding. I like to see what constitutes that number, so I add together the common shares issued, stock options outstanding and warrants issued. Then I review the terms of the the warrants and options to get a feel for the stock price at which maximum dilution would occur.

6. If you are looking at anything less than a “large cap” company, potential financings must always be considered. I have been sideswiped on several occasions by a private placement or financings at a discount to the current stock price that have deflated a stock on the move. I like to see enough cash on the balance sheet to sustain the business for at least 18-24 months so the company is not hand to mouth each month, although for some small cap stocks, it may be closer to 12 months. For these type companies, the Management Discussion and Analysis will often provide the burn rate for the company. If the burn rate is provided, divide the total of the actual cash on hand, plus short term investments, plus the accounts receivable (a little tricky, but assume A/R is a fairly consistent number) less the accounts payable by the burn rate and you will have a crude idea of how many months of cash the company has available.

The above are just some simple review steps that even non-accountants should be able to undertake to gain a better insight into the companies they have stock ownership in.

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs.

Friday, March 18, 2011

Confessions of a Tax Accountant - Week 3- Last Years Missed Medical and Charitable Donation Receipts

I have received 30 client income tax returns to date, I still have over 190 outstanding. I provide these figures to provide support for my blog Personal Income Tax Filing Delays-Late and Amended T-slips, in which I discuss the havoc that the March 31st filing deadline for T3’s and T5013’s causes for accountants and tax preparers by condensing the income tax filing season into a 3-4 week period. I would suggest this havoc wreaked upon income tax preparers can only be detrimental to the Canada Revenue Agency's ("CRA")  clients, that being you the taxpayer or our clients in this specific situation.

Careful to not hurt myself stepping off my soapbox, this week I encountered two very common income tax filing issues. In reviewing a clients income tax return, I found mixed in together with my clients 2010 donation receipts, a donation slip for 2009. Another client had a summary orthodontic bill (many clients lose their medical receipts and ask for a summary print out from the massage therapist, orthodontist etc) for their son that included a substantial amount of work for 2009 that qualified as a medical expense.I discuss how to deal with these issues below.

Last Years Charitable Donations and Medical Receipts

As charitable donations can be carried forward to any five subsequent years, we typically include a prior year’s donation slip in the current years return. We have never had an issue with the CRA in this regard. If the donation was substantial, we would probably file a T1 adjustment to be safe. However, if you are like most people and have missed a $25 or $100 donation from 2009, I would just include them with your 2010  donations in preparing your return.

Last years medical receipts are more problematic. Medical expenses may be claimed for any twelve month period ending in 2010. Thus, if you missed a large 2009 medical expense, you may want to either file a T1 adjustment for the prior year to include the receipt or if you used a twelve month period that was not the calender year, you may want to file a T1 adjustment to change the twelve month period ending in 2009. Alternatively, you may want to consider including the receipt in a twelve month period ending in 2010.

Unfortunately for medical expenses, calculations are often required for the different permutations and combinations of filing scenarios.

It should be noted that the 12 month period ending in the year may be varied from year to year and these periods can overlap. However, obviously you cannot claim the same medical expense twice if you overlap the periods.

[Bloggers Note: In my Confessions of a Tax Accountant blogs, I will discuss real income tax issues that arise, but embellish or slightly change facts to protect the innocent, as the saying goes.]

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs.

Thursday, March 17, 2011

1000th Page Read- CRA Audit-Will I Be Selected

I started my blog in September 2010 figuring I needed to get with “social media” and because I like to write and usually have an opinion. My initial goals were to have someone other then my immediate family read the blog and maybe attract a corporate client or two over time.

This month two of my blogs registered over 1000 page reads which is a personal milestone. I know page reads are not unique reads (but that is all Blogger gives you) and for many bloggers 1,000 page reads may not mean much; but being slightly self indulgent, it means at least my objective of being read by more than my family is being achieved.

One of the reasons (beside the titillating subject matter) my blog CRA Audit-Will I Be Selected hit this milestone was the traffic directed to the blog by a notation by Ram Balakrishnan of the Canadian Capitalist in his weekly blog roundup.

I previously have had the opportunity to thank Larry MacDonald, Rob Carrick, Dianne Nice, Jim Yih and Michael James for their support of my blog, but by happenstance, I have not had that opportunity to thank Ram and wish to do so now.

As the Canadian Capitalist is amongst the most recognized financial blogs in Canada, it requires no introduction. However, I would like to note that besides Ram’s very practical and insightful blogs, you should read the comments and answers on the blog, as Ram’s answers are often as educational as the blog itself.

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs.

Wednesday, March 16, 2011

Filing Income Tax Returns For Your Children and University Students

Michael James recently posted an excellent blog on why parents should file income tax returns for their children (or better yet, have their children actually try and file their own returns). The blog mentions several good reasons for filing and I suggest you read that particular blog. If you do not read Michael's blog, I recommend you do so. Michael digs down deep for practical tips and it feels like he has exeprienced first hand almost everything he writes about.

I agree wholeheartedly with the reasons Michael sets forth for filing a return for your child, or more specifically, your university aged child. However, as an accountant, it is always $signs that matter and I wish to add a couple other reasons for filing (Michael, thanks for the permission) that will result in cash in yours or your child's pocket, especially for children 19 years of age and older.

The Goods and Services Tax/Harmonized Sales Tax credit will pay $250 to low income earners 19 years of age and older. The credit is generated by the filing of a tax return and should be filed by those 18 years of age or older (file when you are 18, so the credit will be received when you are 19). For dependants under 19, the parents may benefit by the credit and their child filing a tax return. For those inclined, the following worksheet  will allow you to calculate your entitlement to the credit.

In addition to the Goods and Service Tax/Harmonized Sales Tax credit, in Ontario there is a $260 Ontario sales tax credit. The eligibility rules for the Ontario Sales Tax Credit are the same as those for the GST/HST Tax credit.I have not delved into the credits allowed in the other provinces, but there are definitely credits available in other provinces.

Finally, again in Ontario, there is an Ontario Energy and Property Tax Credit  where your child is over 18 and has paid rent in Ontario (sorry Ontario students attending UBC, McGill etc.). There is also a small $25 student residence credit  that makes you wonder why Ontario even provides such.

To reiterate one of Michael's points; tuition, education and textbook credits that cannot be transferred to a parent or grandparent, will be available to reduce future income tax on future earnings, most likely in the year your child becomes employed full-time, so ensure your children files to establish these credit carryforwards.

Today’s Music

I have always had this romantic notion, misguided or not, that if I was born ten years earlier, my life would have been more interesting as I would have experienced the social change and music associated with the late 1960's, instead of the banality and disco's of the early 1980's. So I recently purchased The Road to Woodstock, written by the promoter of Woodstock, Michael Lang, to get the inside scoop on the famed festival.

The book was a nice, light, entertaining read for any lovers of 60’s and early 70’s music with some interesting stories and anecdotes by rock and roll legends.

The cultural significance of Woodstock has been debated over the years, but I would suggest the significance of music to the youth of the day can't be debated. That is what I find sad today; the number of teenage kids who listen to 60’s and 70’s music is huge. Where is the music they identify with? Yes, rap seems to have an audience, but it appears limited. Maybe the issue is that life in North America has generally been fairly good and the need for rebellion through music has not been required. Alternatively, maybe most of today’s music just sucks. J

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs.

Monday, March 14, 2011

The Kid in the Candy Store: Human Nature, RRSPs, Free Cash and the Holy Grail

Several weeks ago I read a column by Rob Carrick titled “Why TFSAs Trump RRSPs for the young and lower paid.”. The column was premised on a paper by Jamie Golombek of CIBC on why TFSAs beat RRSPs as a better retirement savings for some Canadians. This topic has subsequently been beaten to death, but in this blog I want to concentrate on the exchange I had with Jamie in regard to human nature and its impact on investing.

The Globe and Mail had an online discussion about the above article and I sent in the following comment: “The problem with technically correct solutions is that they ignore human nature. As a Chartered Accountant I can tell you people consider their RRSPs holy and try their best to never withdraw from them. A TFSA or any accessible account is like candy, you stare and stare and then indulge.”

Jamie responded "you may be surprised to learn that that 80% of all RRSP withdrawals are made by individuals under age 60, generally pre-retirement! Not much of a holy grail!" Jamie's paper also reports that recent data shows 1.9 million Canadians withdrew $9.3 billion from their RRSPs in 2008 and taken in conjunction with the 80% withdrawal statistic noted above, suggests RRSP funds are being used well before retirement age to supplement income.

Jamie clearly considered the human nature aspect of investing in his report (see Accessibility of Funds on page 5) and provides statistics to develop or support the thesis of his paper. I have no issue with his statistics or his assertion RRSPs are being used to supplement retirement income by those under the age of 60. I do object however, to his contention that RRSPs are not considered the Holy Grail.

In my practice, I have observed that RRSPs are the Holy Grail for most of my clients. More importantly, RRSPs seem to act like those invisible fences for dogs and form an invisible barrier to prevent my clients from "grabbing" at their RRSPs; although I think Jamie would suggest the barrier may have some holes in it based on his statistics.

I asked Rob Carrick his thoughts on the matter and he responded, "I'm stunned every time I read stats on how many people take money out of their RRSPs, never mind TFSAs. The harder it is to withdraw from a retirement savings vehicle, the better."

On the surface, it is difficult to refute Jamie's assertion without my own statistics. Numbers are numbers. But, if we could dig a little deeper the same numbers may tell a different story. Here is where human nature and its impact on investing come into play. Human nature, like physical nature, takes the path of least resistance. At the end of the day, my professional observation of human nature takes me down the same road as Rob: the greater the barrier, the better - even if some ignore the barrier. Anyway, I will leave this for the psychologists to study and will return to my laboratory, being my office, and provide some personal experiences on human nature and free cash.

RRSPs, The Holy Grail Or Just Full of Holes

In my accounting practice, it has been my experience based on discussions with my clients, that they withdraw RRSPs almost exclusively for financial need only and not for discretionary purposes. I will concede that my client’s incomes are well above the national average and thus they may not be a representative sample. If we could somehow ask each person who withdraws funds from their RRSP in Canada, “why are you doing such and what is the intended use of the funds?", I am convinced that the vast majority would answer we are taking out the funds due to financial need and not for discretionary purchases. Most people take a certain pride and comfort in their RRSP savings. There is a peculiar permanency in investing in an RRSP that is not nearly as tangible in a TFSA or other savings account. Non-RRSP savings accounts seem to represent “leftover money”. RRSPs represent security from old age impoverishment. That is the Holy Grail. Most people cash out RRSP’s only under financial duress. Financial duress is not the same as supplementing income.

So what about those alarmingly counter-intuitive statistics that would suggest we have become an unholy nation desecrating their RRSPs? It is highly probable in my humble opinion, that many Canadians are convinced that they have to contribute to a RRSP by the various advertisements they are bombarded with in January and February each year by financial institutions and at the urging of financial commentators and in fact, many were really not in a position to contribute to their RRSP in the first place, thus dooming their RRSP from inception and inflating the withdrawal statistics.

I See It, I Want It

Now, assuming we are not compelled to withdraw our savings (or perhaps more aptly borrowings), restricted savings accounts are like invisible fences, or the glass in front of the candy counter. Withdrawing cash from an accessible savings account like a TFSA is relatively easy. Especially when we see that cash as “leftover earnings”, or as a well-deserved reward for how much we’ve earned or how hard we’ve worked. If we move away from restricted accounts such as RRSPs, the invisible fence seems to turn off. Now the buying is easy. Self-restraint is hard. Accessible cash quickly winds its way along the path of least resistance and a cash register.

I often observe the sweet lure of accessible cash in the actions of many self-employed individuals and professionals in respect of their quarterly personal income tax installments. Some make significant sums of money, but you would not believe how many don't have the funds to make their quarterly income tax installments. This results in huge income tax liabilities around April 30th and installment interest and penalties for failure to make these required installments. Why don’t they have this cash you ask? In some cases they have not collected their accounts receivable or received allocations from their partnerships, but in many cases, they have spent the free cash that should have been allocated to their income tax installments on discretionary items only because it is was easily accessible and winking at them.

A hot topic that has been widely debated recently is whether it is better for small business owners to eschew salary and RRSPs in favour of leaving the funds in their holding company. Technically leaving the money in the corporation is correct (although I have some reservations with this strategy because you stop RRSP contributions, lose eligibility for CPP income in the future if no salary is taken, and potentially forgo the deductibility of child care expenses if no salary is taken) but in my opinion, the candy (ie: available cash) will prove too tempting for most people and some of those corporate funds will find their way to cover that vacation they wanted in Europe or that new car or boat they have their eye on; whereas if those funds were contributed to a RRSP, the invisible fence effect would come into play. I have observed this first hand with the typical current holding company structure where excess profits from a operating company are moved to the holding company; this new twist would only create more accessible cash to potentially be withdrawn.

Intuitively Rationally Irrational

Although not directly related to free cash, an example of personal behavior superseding fundamental financial common sense is in relation to income tax refunds. Individuals can file a form T1213 to obtain waivers to reduce income tax withholdings in certain circumstances, but almost no one does. Ignoring the administrative issue of obtaining the income tax withholding reduction, which may contribute in part, individuals just love their lump-sum tax refunds (usually as result of their RRSP contributions) and they intuitively know they would not save an amount equal to the same lump-sum income tax refund if they had their income tax withholding reduced on a bi-weekly or semi-monthly basis.

I have only anecdotal evidence to prove people consider their RRSPs the Holy Grail. But really, is it unreasonable to accept that TFSAs or other non registered accounts are merely shelves displaying the cash candy to which our sweet tooth cash cravings will inevitably succumb? The path of least resistance generally ends at the cash register in the candy store. The high road is easier to follow when the candy case is locked. A financial vehicle that people feel is “locked in” will help stymie our natural inclination to self-indulge and spend and will only be accessed under financial duress and not necessarily as a supplement to retirement income. Now that is a Holy Grail indeed.

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs.

Friday, March 11, 2011

Confessions of a Tax Accountant - Week Two- T1 Adjustments for Statute Barred Years

As of today, I have received less then 10% (21 returns) of the client income tax returns I will prepare.The returns submitted thus far are typically my less complex returns and have only a few slips such as T4’s, T5’s, RRSPs and maybe some stock trading or a rental property or two. These returns can be filed without waiting for additional slips. As the majority of my returns require T3's and T5013's, I will not be seeing most of my returns for at least a couple weeks.

I do not have much to report income tax issue wise this week, but I did receive a notice of re-assessment for a client that brings up an interesting filing issue if you have missed claiming income tax deductions or credits in prior years.

T1 Adjustments For Statute Barred Years

In years gone by, if a client wanted to adjust their personal income tax return for a missed deduction or credit for multiple years, or more then three years after they had been initially assessed, the Canada Revenue Agency (“CRA”) would typically deny such a request, since the tax returns were statute barred. Such adjustment requests were often made for disability credits not claimed, medical and donation receipts not claimed and interest expense not deducted amongst various other reasons.

However, as a result of the “Fairness” legislation, the CRA is now allowing most requests that cover multiple years. The following is what is typically printed by the CRA on the re-assessment notice for one of these adjustment requests.

“As you requested, we have adjusted your return. In the past, you had to make such a request within three years of the date we mailed you the “Notice of Assessment” for that return. However, the taxpayer relief provisions of the “Income Tax Act” allow us to make adjustments beyond the usual three year period. Since we allowed you an adjustment under these provisions, you cannot file a notice of objection regarding this reassessment.”

Since in almost all cases you are asking for a refund from CRA, the fact you cannot file a notice of objection is typically a moot point and a small concession especially in comparison to the fact the CRA will probably accept your multi-year adjustment request.

If you or anyone you know has missed claiming a deduction or claiming a credit on a return assessed over three years ago, you should consider preparing a T1 Adjustment Request, since in most cases it will now be accepted.

[Bloggers Note: In my Confessions of a Tax Accountant blogs, I will discuss real income tax issues that arise, but embellish or slightly change facts to protect the innocent, as the saying goes.]

NHL- Just Act With Some Common Sense

The hit by Zdeno Chara on Tuesday night against Max Pacioretty was a vicious hit. In my opinion, in real time, it appeared to be what is commonly known as a “hockey play”. However, whether it was or was not a hockey play is irrelevant and the result was horrific.

Since the players obviously will not police themselves or respect their own, the NHL should take two simple steps to clean up the head-shot and icing mess. If I was in charge of the NHL, I would implement two simple rules:

  1. Automatic icing. There are 3 plays out of a 100 where an offensive player actually wins the puck, so why risk the head and "lower & upper body" injuries that often occur on chases to the puck on icing plays.
  2. Automatic suspensions on any hit to the head or any hit that causes an injury to the head, whether it appears intentional or not. Ten games the first time (with leeway to increase it if circumstances dictate such), twenty five the second offence (with upward adjustment leeway) and a years suspension the third time a player goes for the head of an opposition player.
There, nice and simple, no discretion other then to increase suspensions. What’s so hard?

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs.

Tuesday, March 8, 2011

Housing Gifts and Loans to Children and Prenuptial Agreements

Over my twenty-five year career as a CA, I have dealt with many professionals who are experts in their field on various client files; from tax lawyers, to business valuators, to venture capitalists to forensic accountants amongst many others. Lately I have taken to asking (okay, twisting their arms) some of these professionals to write or provide comments for my blog on their specialties. Today marks the first of what I hope will be many contributions over time from these experts, with a family law contribution from Stephen Grant of McCarthy Tetrault.

Prenuptial Agreement or Family Feud?

I have recently blogged about considering a family meeting to discuss your will and the taboo topic of money amongst family members. However, the potential fireworks in confronting both those issues is like comparing a sparkler to a roman candle when it comes to your dear child entering into a new marriage.

It has been my experience that parents are loathe to discuss prenuptial agreements with their children once their child is in a serious relationship, as the children take any discussion as an affront upon their boyfriend/girlfriend or future better half. Thus, I try to raise the issue of future prenuptial agreements with my clients and their children when their children are just entering university, especially when the child has ownership in a family business or significant assets in their name.

I suggest this timing for two reasons: (1) the child is old enough to consider and understand the concept of a prenuptial agreement; (2) they will remember that you discussed this topic before they found the love of their life and thus, they will not necessarily consider it a personal attack upon their future spouse when you raise the issue of a prenuptial agreement.

For most families, the issue of share ownership or your child owning significant assets is a moot issue. However, in Toronto I see many parents gifting money to their children to help them purchase their first house, which I assume if a fairly common phenomenon across most of Canada. When I am informed or asked for my advice on housing gifts, I always advise my clients that they should go see their lawyer. I know most lawyers will then tell them that the gift should be documented as a mortgage or promissory note. By doing this, the parent will hopefully be entitled to get the loan back in the case of marital breakup.

The keen eyed will note I said "hopefully" above. I qualify my comment because the courts have discounted the value of the debt (mortgage or loan) where a judge has felt the debt was not valid and/or the child of the parent, who loaned the funds, would never be called upon to repay the debt to their parents. It is therefore imperative parents get proper legal advice to understand the best way to evidence the validity of the debt; which typically involves their lawyer drafting a debt document that has an interest rate and default and payment terms, to establish the debt is a bona fide debt and not a gift.

Noted Toronto litigation and family lawyer Stephen Grant of McCarthy Tetrault offers these further suggestions to protect family assets upon the marriage of your children.

  • Make gifts (or inheritances) after, not before, a marriage.
  • Explain to your children the importance of keeping assets segregated – especially ones that emanate from a post-marriage gift.
  • Create a holding company for each child. “Gift” the holding company shares to that child after marriage and pay all future gifts to the holding company.
  • Ensure that your own will has the requisite clauses to enable you to bequeath both capital and investment income such that the offspring recipient can exclude both from his or her net family property.
  • If the parent undertakes an estate freeze to transfer a company to his/her children, ensure that the child does not "subscribe" or purchase the Newco shares, but that the shares are gifted.
Stephen suggests that your child gets legal advice about the financial consequences of marriage and divorce before marriage.

As someone who has seen clients directly or indirectly lose thousands of dollars upon the dissolution of their child’s marriage, I suggest you heed Stephen's advice above.

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs.

Monday, March 7, 2011

Tax Tips

I have written a guest blog entitled Tax Tips from a Blunt Bean Counter for Jim Yih on his Retire Happy Blog.

The blog is self descriptive. It is a meat and potatoes listing of various tax tips to consider.

When visiting Jim's blog, take a look around, lots of good stuff.

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs.

Sunday, March 6, 2011

My Secret Goal Tape- Billy Smith Exposed by The Blunt Bean Counter

As I noted in a recent blog , I was a winner in the Mr. Sub Shootout and  had the opportunity to  take two penalty shots on ex-NHL goaltender, Billy Smith. I actually managed to score once and here is the link to YouTube that provides video evidence for anyone interested. After viewing the video, I now know why Billy told me after my goal that "if I tried that in a real game, he would have knocked me flat". My head was down and he let up, but, hey, a goal is a goal. 

I have also attached a few pictures from the event. It was a fun day and a great experience for all who participated.

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs.

Friday, March 4, 2011

Confessions of a Tax Accountant - Week One-Income Tax Withholdings on RRSP's and Termination Payments

In this weeks edition of Confessions of a Tax Accountant, I  will provide some initial perspective on my tax season and discuss an income tax issue that arose.

I will be responsible for approximately 230 personal income tax returns, which are due in most cases by April 30th. In addition, I have numerous other corporate and proprietor year ends that require corporate income tax returns and/or financial statements, which typically need to be completed during this busy time. To date, I have only received four personal income tax returns.

From a hourly workload, working for a mid-size firm is definitely a benefit. In my younger days I used to work seven days a week often until after midnight. Nowadays, if no special assignment occurs during tax season, I will typically work six days a week until April, at which time I will then usually work seven days a week. As I have a large staff to delegate to, suffice to say I don't work the crazy hours I once did.

This year I stopped preparing US personal income tax returns, as the IRS regulations and penalties have become overwhelming, extremely punitive and not worth the effort and risk.

Most of my personal income tax returns are very complex. I have several CEO-types, very successful business owners and well paid employees with everything from foreign investments, rental properties, limited partnerships, commodity trading, etc. If there is something to be invested in, these people invest in it. Besides being complicated, these returns present timing issues as I discussed in an earlier blog “Personal Income Tax Filing Tax Delays" in that most of these returns will not start coming in until the first week of April as my clients await the arrival of T5013 and T3 slips and these slips will not arrive  until the end of March and in many cases, as late as mid-April.

Okay, that is it for perspective, onto a tax issue that arose this week.

Statutory Income Tax Withholdings on RRSP's and Lump Sum Payments

A common income tax issue that arose this week was in respect of RRSP withdrawals. A client withdrew money from their RRSP back in January 2010, which is now over 13 months ago. My client asked me if they were going to receive a tax refund this year. I told them "my staff has to input all the slips, but I can tell you right now, you will not get a refund and will most likely owe at least 16% of your total RRSP withdrawal in tax.” My client was stunned as I explained that 10% is withheld on RRSP withdrawals up to $5,000, 20% is withheld on withdrawals between $5,000-$15,000 and 30% is withheld on withdrawals greater than $15,000.

This issue is very common and problematic. Clients assume that the income tax withheld on RRSP’s and retiring allowances (often called severance pay) at source are the proper income tax withholdings. However, these withholding rates are only statutory and in my client’s case, with their employment income putting them in the top marginal rate, the income tax rate applicable to their RRSP withdrawal will be 46.4%, not 30%, hence a 16 point shortfall.

The Canada Revenue Agency even states the following on their website in respect of lump sum payments like RRSP's and retiring allowance payments: "Recipients and employees may have to pay additional tax on these amounts when they file their returns. To avoid this, if a recipient or an employee requests it, you can deduct more tax".

This is a very hard planning issue. Many personal tax clients do not call me before they withdraw monies from an RRSP and they assume the income tax deduction will be sufficient. Where a client has had their employment terminated, they typically call me because they usually get a letter outlining options from their former employer suggesting they speak to their advisors. In those cases I can calculate the income tax shortfall on the withholdings and can inform them what to put aside for their additional income tax payments.

In any event, if you collapse a RRSP or have a retiring allowance, you always need to be cognizant of the fact the income tax withholdings will probably be "lite".

[Bloggers Note: In my Confessions of a Tax Accountant blogs, I will discuss real income tax issues that arise and are general in nature, but I may still embellish or slightly change facts to protect the innocent, as the saying goes.]

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs.

Tuesday, March 1, 2011

Introducing a Family Trust as a Shareholder in a Private Corporation

Two weeks ago I discussed using a holding company as a simple method to creditor proof excess corporate funds or other assets in a private corporation. In this blog I will discuss a “fancier” and far more complex transaction that can not only achieve creditor proofing, but potentially provides a means to income split with family members, potentially provides multiple access to the $750,000 capital gains exemption and finally, may provide a means to crystallize or "freeze" the income tax liability related to your company's shares at death.

For the purpose of this blog, I will  use the example of Starlet Yohansen who owns all the common shares of Movie Star Limited ("MSL"). The shares initially cost Starlet $1 and are now worth $3,000,000.

For Starlet to concurrently achieve all the objectives noted above, she would typically “freeze” the value of her  common shares in MSL. At the date of the “freeze”, Starlet would exchange her common shares for special preferred shares with a value equal to the value of the common shares exchanged, that being $3,000,000. Thus, at this point in time, there are no common shares and Starlet owns special shares worth $3,000,000. These special shares cannot increase in value, hence the term "freeze".

Any future growth in the value of MSL over the current value of $3,000,000 will accrue only to the new common shares that are issued as part of this reorganization. That growth will accrue directly, or indirectly through a family trust, to potentially Starlet's family members and/or a Holding company by having them subscribe for the new common shares issued in MSL (Starlet can also maintain some of the future growth if she subscribes for the new common shares or is included in the family trust). Often we see this strategy being used in succession planning when the owner-manager wishes to transfer ownership of their operating company to the next generation, but this strategy can be used without succession being the objective.

The beauty of the freeze is that Starlet's maximum income tax liability on her MSL shares has been established (unless she subscribes for more common shares). At Starlet's death, her income tax liability on her MSL shares will be equal to $3,000,000 times the applicable income tax rate at that time, likely around 23%. As Starlet knows the maximum income tax liability on her special shares she can plan to pay this liability by putting aside funds or by purchasing life insurance.

In addition, we often further reduce Starlet's  income tax liability by redeeming her frozen shares over time, which typically creates a current taxable dividend to Starlet, but also serves to reduce the value of the frozen shares by essentially the value of the dividend reported [ie: if Starlet redeems 500,000 shares that have a paid up capital and adjusted cost base of $1, she will have a deemed dividend of approximately $500,000 to report on her personal income tax return and her special shares are now only worth $2,500,000 ($3,000,000-$500,000 redeemed)]. Thus, if Starlet lives long enough, much if not all of her income tax liability can be eliminated prior to her death by redeeming her shares slowly over time.

If Starlet uses the Yohansen Family Trust to subscribe for the new common shares of MSL, the beneficiaries of the family trust would typically include Starlet, her spouse (although given Starlet's past history, we may want to leave her spouse out of the trust), her children and a Holding company. The inclusion of these beneficiaries can provide tax-effective income splitting on dividends received from MSL when the children are 18 years of age or older or when a spouse is in a lower income tax bracket (Starlet may have a trophy husband who does not have much income). The trust can also provide tax-effective income splitting on the sale of a business irregardless of the beneficiary’s age.

Generally, a family trust is discretionary. The trustees can tax effectively allocate the income received by the trust (i.e. dividends from MSL) to any or all of the beneficiaries including Starlet, so long as they are 18 years of age or older. A beneficiary who is 18 years of age or older and has no other sources of income can receive up to $37,500 in dividends tax-free. This strategy is a great way to help fund a child’s post-secondary school education (in addition to an RESP) or other expenses, while also lessening the family’s overall income tax liability.

If the shares of MSL are sold in the future, any sale proceeds in excess of the value of Starlet's original  frozen special preferred shares ($3,000,000 maximum) can be allocated to the beneficiaries of the trust. This may permit the utilization of the $750,000 capital gains exemption by each of these beneficiaries. A word to the wise though, any sales proceeds allocated to a beneficiary of the trust, including a minor child, will result in the money legally belonging to the child.

Finally, back to the original creditor proofing issue. The inclusion of a Holdco as a beneficiary of the trust would provide a means to transfer any excess funds in MSL as a tax-free via a dividend from MSL to Holdco thus creditor proofing the excess cash in MSL by moving it to Holdco.

I am sure there are very few readers still awake or with eyes not glazed over; but believe it or not, this type of reorganization has been simplified greatly for discussion purposes. There are several pitfalls along the way and in the future that must be avoided in order to successfully achieve the objectives noted at the beginning of this blog. If you are contemplating undertaking such a transaction, you must consult your accountant and lawyer to ensure that the transaction makes sense given your personal situation and that no details are missed in carrying out the finer points of the reorganization.

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs.