Not all interest income is treated the same by the tax man
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Colin MacAskill
When deciding where to invest, it’s important to consider how various types of investments are taxed. Investments within a registered plan such as an RSP are tax-deferred — you don’t pay taxes until you start withdrawing money from the plan. But when you’re investing outside an RSP, you must report your investment income every year for tax purposes. Because income from certain types of investments is taxed more favorably than other types, you should evaluate investments on an after-tax basis, not a pre-tax basis.
Interest income
The Canada Customs and Revenue Agency treats interest income — such as interest from savings accounts — in the same way as most other income. It is taxable within each tax bracket at the applicable rate. In other words, there is no tax advantage with interest income.
Reporting this type of income can be tricky. How you report it depends on when the investment was made, and also on what type of investment it is. If the investment was made in 1990 or after, any accrued interest earned must be reported annually. Accrued interest is interest that you have not yet received, but has accumulated in a particular investment.
Income from compounding securities — like GICs, strip coupon bonds and Canada Savings Bonds — must be reported by the same method, called the accrual method. It must be reported every year, even if you don’t actually receive the income in that year.
Capital gains
Capital gains can occur when you sell an asset, or you are deemed to have sold an asset. Proceeds from the sale in excess of the cost base of the asset, including any commission charges, are taxable. For sales in 2001 or after, your net capital gain is taxed at only half of the applicable combined federal and provincial tax rate. A net capital gain is defined as your total capital gains minus total capital losses.
In addition, there is a $500,000 lifetime capital gains exemption for shares of a qualified small business corporation or a qualified farm property.
Dividend income
You pay less tax on dividends from a Canadian source than on interest income and capital gains. Investing in Canadian companies that pay dividends is certainly a tax-effective option, but it is also important to consider other factors, such as the opportunity for capital appreciation and diversification.
Dividend income is taxed in the following manner: the amount of the actual dividend is “grossed-up” by 25 per cent. The federal tax is calculated. Then the federal dividend tax credit — 16.66 per cent of the actual amount of the dividend — is deducted from the federal tax. Provincial taxes are calculated in a similar way, using provincial tax rates and the appropriate provincial dividend tax credit.
This publication is not intended as nor does it constitute tax or legal advice. Readers should consult their own lawyer, accountant or other professional advisor when planning to implement a strategy.
This article was supplied by Colin MacAskill, a vice-president and an investment advisor with RBC Dominion Securities Inc., the wealth management arm of the Royal Bank. Member CIPF. MacAskill welcomes your calls on his direct line 604-257-7455
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