March 19, 2008 by Dan White.

Seek advice before making mortgage manoeuvre

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Mar 15, 2008 04:30 AM

Bob Aaron
The pitch sounds very seductive. “Go ahead. Make your mortgage tax deductible. Yes. It can be done. Yes it’s legal.”

The pitch is used to promote an investment technique called the Smith Manoeuvre.

According to Smith Manoeuvre Financial Corporation (smfc.com), “the Smith Manoeuvre is a financial strategy that simultaneously converts mortgage interest to tax deductions, shortens the amortization of your mortgage and builds a free and clear pension portfolio for your retirement – funded through your monthly mortgage payments and without requiring any additional monthly cash investment!”

The investment strategy is explained in a book called The Smith Manoeuvre: Is Your Mortgage Tax Deductible? by Canadian financial guru Fraser Smith (Outspan Publishing, $24.95).

But it may not be quite as rosy as it sounds.

Writing in the March issue of REM (Real Estate Magazine, remonline.com), a monthly publication for industry stakeholders, tax specialist Dan White sounds an alarm about using the strategy.

In providing a glimpse of the “dark side of the Smith Manoeuvre,” he cautions anyone contemplating using the technique to “think again and think carefully.”

Here’s how the program works: The homeowner obtains what the Smith people call a re-advanceable mortgage –which is basically a mortgage combined with a line of credit, where the balance can fluctuate from time to time.

As the homeowner pays down the principal with monthly payments, he or she then immediately has that amount re-advanced in order to invest in stocks, bonds or other real estate. In theory, that portion of the loan used for investments – and that portion only – is tax deductible.

In other words, the interest paid on the “re-advanced” portion of the loan can be used to reduce investment income.

According to White, the “significant flaw” in the scheme is when the primary purpose of using it is to make a home mortgage tax deductible, it leaves the homeowner vulnerable to attack by Canada Revenue Agency.

Under CRA rules, interest paid on money used from a mortgage to produce capital gains is not tax deductible.

As a result, if a Smith Manoeuvre loan is used to buy stocks mainly for the purpose of capital appreciation, the interest is not deductible.

Interest can only be deducted as a legitimate business expense if it is used to invest in an active business to generate business income. “Even so,” warns White, “if you are going to do this kind of stuff, you need to think it through, get good advice and set yourself up strategically.”

White reminds REM readers that the government is always looking for ways to generate more income. “There is a reason they call it the Canada Revenue Agency,” he adds.

For occasional or passive investors, White warns that the Smith Manoeuvre could be a costly mistake.

“If you are doing this with your principal residence and you claim 100 per cent of your mortgage interest as a business expense, then there is a strong argument that your home is a business and as such, you are not exempt from capital gains on the sale of the residence,” he writes.

White is not alone in criticizing the investment strategy.

Writing in the Star in January, 2007, Ellen Roseman quoted some critics of the Smith Manoeuvre. Among them was Gary Newby, a certified financial planner in Toronto.

In Roseman’s column, he warned, “It’s not good for the average person. Most of my clients wouldn’t understand it because it’s very complex.”

David Trahair, a Toronto chartered accountant, is also quoted in Roseman’s column.

“It’s a high-risk strategy,” he says, “because you’re betting the farm that some investment adviser can do better than you can.”

I agree with the critics of the Smith Manoeuvre. It’s far too risky for the average homeowner.

Always obtain tax advice from a qualified person, such as an accountant or tax lawyer, who is not selling or promoting anything, and to whom the client’s interests come first.

If the tax adviser stands to make a commission selling participation in a scheme like the Smith Manoeuvre, he or she is in an obvious conflict of interest and the advice can hardly be said to be impartial.

Bob Aaron is a Toronto real estate lawyer whose Title Page column appears Saturdays. He can be reached at bob@aaron.ca. His website is aaron.ca.

Posted in Tax Tips For Real Estate, Tax Tips | Print | 2 Comments »

March 14, 2008 by Dan White.

Family businesses confront touchy EI rulesThe Canada Revenue Agency disputes that a third party is much help navigating the rules
By Bill Steinburg - Business Edge Published: 10/13/2005 - Vol. 5, No. 35
Note from Dan White. Grants specializes in getting money back on behalf of abused Canadians. You can do it yourself if you are good at these types of things.   The fact that a business can survive solely on being in the business of getting money back from CRA shows just the tip of the iceberg when it comes to unfair and unreasonable positioning of CRA.   Like many employees in a Canadian family-owned business, Joseph Pariselli has paid employment insurance premiums for many years. However, the Concord, Ont. construction manager recently learned he would not be eligible to collect those employment benefits if he lost his job with his older brothers’ landscaping company, Par-Bro Design/Build Ltd. Pariselli is among thousands of people working for relatives in a family business whose eligibility for EI might be questioned by government. He applied for employment insurance several years ago, when Par-Bro closed during the off-season, and was initially turned down. He eventually did receive benefits but “had to jump through hoops” to get them, according to Par-Bro controller Vince Cappelli, who filled out a mountain of paperwork over many months. The problem stems from the roles relatives often play in family-owned businesses. “In the legislation it says that if you work for a family member, you are automatically deemed excluded unless you can show that you work under the same working conditions as any other workers,” says Francine Blouin Wilkinson, director of benefit entitlement and coverage for the federal department Services Canada. Employment Insurance Act states that if a family employee is paid about the same, works roughly the same hours and has the same status within the company as other workers with similar jobs, EI premiums should be deducted and the person is eligible to claim EI benefits. Pariselli’s situation, as the brother of Par-Bro owners, raised questions as to whether his role in the company was, in fact, the same as other employees. These are questions Darren Earn, president of Winnipeg-based Grants International Inc., deals with on a daily basis. The company helps employers such as Par-Bro and employees such as Pariselli clarify their rights with the government. “There are roughly half-a-million family members right now deducting and paying close to $2,000 a year (to EI),” says Earn. “That’s $1 billion a year in over-collected EI for people who may or may not be eligible to collect it. Earn says many companies and affected employees truly want to pay the premiums and receive the protection of EI, so they never investigate their eligibility. “They don’t know until they actually make a claim for … benefits,” he says. “They find out the hard way.” Earn started Grants International in 1991 to help companies access government grants. The services eventually expanded to include the review of records for possible payroll tax overpayments and the issue of EI premiums came to light. Now, Grants International calls itself “the EI refund specialists.” Hearing a Grants International commercial on the radio, Cappelli called to find out more about Pariselli’s eligibility - an exemption means as much to the company as it does the employee, since both pay premiums. Earn says the same sort of scenario happens in family businesses across the country. “These are all very, very subjective areas where the government has to make a decision on whether or not to let you collect,” he says. “If they decide not to let you collect, you remain excluded. It isn’t the other way around: ‘Oh, you paid your premiums all these years, so you can collect.’ It’s the opposite: ‘Oh, you’ve paid your premiums all these years, but you’ve been ineligible all this time. You can’t make a claim for benefits.’ You’ve got to prove to them that you should get them.” Complicating the issue further, according to Earn, is that a ruling made today has little bearing on the future. “That letter that says you can collect EI means nothing because in three years, the reason why you would be collecting employment insurance is that something must have happened to the family business,” Earn explains. “When things happen to the family business, you’ll see on a regular basis, other employees will be laid off over time and the last standing members are the family members. They do things that are so not substantially similar at the end when times are tough, and they become immediately ineligible for benefits as soon as those circumstances change.” Blouin Wilkinson says such situations can change a person’s eligibility, but stressed that the system is fair, adding that anyone who wants to confirm their EI status can contact the Canada Revenue Agency (CRA), which collects premiums and rules on eligibility for Services Canada. “Most people who work under regular conditions will be eligible to pay in, and they do pay in and they want to be paying in,” she says. “Most people want to be covered because you want to be paid your EI. That’s your insurance and most people want to be covered by that insurance because if they get laid off … then they can collect EI. All they have to do is have CRA rule on it and CRA will give them the answer.” The reality, according to Earn, is that trying to secure an exemption from paying premiums is more complicated if you have already been making contributions. Once employees are in the system, he suggests the government wants to keep them there. “Keep in mind, (the CRA) is collecting your money at this point,” he says. “They are trying to figure out all the reasons why you should pay. They are trying to make you look substantially similar (to others) in your contract of employment at that moment because if they can, that means you have to continue to pay and you’re not making a claim for benefits. “When you do (make a claim), they are doing the exact opposite: Protecting the system, figuring out all the reasons why you are not eligible. That’s their job and I don’t blame them for that. If their job was to give out refunds, everything would be really easy.” Wilkinson admits that some people find it difficult to deal with the government. “Every day, we are trying to simplify that - though I know we have a long way to go.? She says people do not need Grants International working for them to determine their EI eligibility. “The way that the website (www.grantsinternational.ca) of Grants is set up, it gives the impression that people should not be paying and that there are big dollars out there to be refunded. And in some cases it may be true because the person has always remitted an EI premium and never really asked whether they should be or not. “But if they do ask, they will get the premiums back,” Wilkinson says. “I would be surprised that the majority of people who thought they worked as an employee and paid premiums have found that they should not have been paying all those years.” That said, Grants International has obviously been busy enough securing exemptions and refunds that the CRA has taken notice. “The CRA in 2003 has checked whether Grants International’s activities didn’t contravene any laws,” she says. “And they found, no, what they are doing is simply assisting individuals in the process that they could have done themselves, but they are just assisting them.” (Bill Steinburg can be reached at at steinburg@businessedge.ca)

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March 12, 2008 by Dan White.

• Provincial taxation of income funds. Under current law, income trusts will become subject to a special “SIFT” tax on distributions made by them after 2010 (or before then if they breach “normal growth” guidelines.) The Budget proposes that the provincial component of the SIFT tax (that will be paid over to the provinces) will be based on actual provincial corporate tax rates in the provinces to which the distribution is allocated (under a formula giving equal weight to relative province-by-province payrolls and revenues) rather than being a flat rate of 13% (as previously announced). (However, the Quebec tax rate will be treated as nil for these purposes given that Quebec separately imposes a SIFT tax.)
• What this means is you can’t trust the income trusts.

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March 12, 2008 by Dan White.

The dividend tax credits available to individual investors receiving dividends from most Canadian public corporations will be significantly reduced on a phased-in basis commencing in 2009, with the final reduction occurring in 2012. This will increase the effective tax rate on such dividends compared to current law.

What this means is that investors need to pay more attention to which investments pay dividends and which do not.

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March 12, 2008 by Dan White.

Tax-free savings accounts. Beginning in 2009, Canadian-resident individuals who are 18 years of age or older will be permitted to contribute a maximum of $5,000 (indexed to inflation) per year to their “tax free savings account” (”TFSA”). To the extent that an individual does not fully utilize his or her contribution room in any particular year, the unused contribution will be carried forward and applied against contributions made in future years. Contributions to a TFSA will not be tax deductible but any income or capital gains realized on the investments held in a TFSA will be exempt from tax and any withdrawals from the TFSA will be tax-free. In order to ensure that there is no loss in an individual’s cumulative contribution room for his or her TFSA, the individual will be permitted to re-contribute amounts previously withdrawn from the TFSA without such re-contribution reducing the individual’s otherwise available annual contribution limits. An individual will also be permitted to make contributions to a TFSA established by a spouse or common-law partner, provided the spouse or common-law partner has contribution room available. Subject to some exceptions, the investments permitted to be held in an individual’s TFSA will be the same as those investments currently permitted for registered retirement savings plans.

What is interesting here is that if both spouses contribute $5,000 per year it can add up and prove to be an excelent tax reduction strategy for retirement time.

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March 4, 2008 by Dan White.

TFSA…  another soon-to-become familiar acronym in the lexicon of government plans and possibly another step on the road to increasing financial complexity which at some point just becomes muck for the mind.  Therefore as my Mom used to say; “It is always good to step back and take a bird’s eye view of a pig’s rump in the moonlight.”

No one can be sure how to build a structure, until you get the blue prints, but it looks like the TAX FREE SAVINGS ACCOUNT (TFSA) will be a good tool for creating wealth.  RRSPs, RESPs, and RIFFs have been far better tools for the government than they have been for tax payers.  However those who have learned to beat the system have done well by the RRSP.  When you understand that an RRSP is not a good tool to use for retirement income, but that it is a good planning tool for retirement you can make good use of them.

Now we begin a new journey as we start to look at TFSAs.  It is first of all most important to see the TFSA account as a “Planning Account.”  Or another way to look at it is as one of the tools in your wealth creation tool box. The highest and best use of a TFSA will be for the purpose of making money.  Real Estate is an established way to make money.  Why not consider using it for that?

The TFSA is nothing short of a brilliant move by our government on several of fronts.  Government has come up with a great way to switch retirement planning tools without upsetting the present applecart.  Something needed to be done as more and more Canadians are realizing that RRSPs don’t save taxes in the long run they just defer them until you can afford them even less.  TFSAs are good for the government as they are a way to get people to pay their taxes now on a portion of their savings plan which, unlike an RRSP, defers the tax until retirement time.   This will be a good money generator for CRA. 

In addition, when Canadians save their money, it creates money in the bank that the government can borrow; it keeps us feeling poor and our noses to the grindstone and in the governments’ mind “Idle hands are the tools of the devil.”  As a minimum it is a way to get Canadians on the band wagon of not needing social help at retirement time.  Using the TFSA to invest stimulates activity in the investment market, which of course is good for the economy even if it is not always good for the investors.

If one can look to the past to predict the future, then as they did with RRSPs, the government will start out small and keep adding more and more deposit room.  I see this as a kind of reverse strategy.  Create a perception of limitation and everyone will go for the maximum.  So my prediction is that people will max out their TFSAs and the amount of the cumulative room in will keep on growing.  And of course the banks will jump on board with the TFSAs being promoted as much if not more than RRSPs.

So, I see the TFSA as a socially conscious thing for our government to do.  I like it.  But as in all government programs there are pitfalls if you don’t watch where you tread.  Get some good guidance and understand that most people lose money with their investments over the long haul.  So do it right and be one of the winners.

TFSAs: The Basics

• Starting in 2009, Canadians 18 and over can save up to $5,000 a year.

• Contributions are not tax-deductible, but all interest and capital gains accumulate tax-free.

• You can withdraw money for any purpose at any time - and repay withdrawals without using up contribution room.

• Unused contributions can be carried forward, there is no lifetime limit and contributions can be made on behalf of a spouse. Limits: $5,000 per year to start.

Allowable investments: Same as RRSPs, which means stocks, bonds, funds and savings accounts.

Basic concept: A TFSA is a vehicle for tax-free savings and investment available to anyone 18 and older.  It is an identifiable place to park money that is not part of your cost of living.  It is not a reasonable place to earn interest unless you already have financial security arranged for your retirement.  Interest is nothing more than preservation of existing capital from bank fees and inflation.

Advanced concept: A tool to use for managing money used to make more money.  The TFSA needs a mental rider; thou shall not use this money for non-discretionary non-money making activities.  The money in needs to be considered the same way most people use RRSPs… as a savings account for retirement.  In this case it is a money making account for retirement planning.

You can use a TFSA for anything allowed for in an RRSP.  The strategy needs to be the intent of using the money to make money.  If you are going to go for passive investments, such as stocks and bonds and GICs then you are never going to get ahead.  If you factor in inflation with a low return, there is no point in doing this.  The money has to make more than 10% or it makes no sense to use a TFSA.

Keep in mind that as much as possible the money going into a TFSA should be after tax dollars from things like gifts, tax refunds and repatriated capital from investments.  You should create a chequing bank account that is dedicated to working with your TFSA to avoid money going for purposes other than that of building wealth.  Oddly enough a good time to make a deposit in a TFSA is when you are at a low marginal tax rate because you pay less income tax that way.

You could also use this money at year end as a tax deferral plan.  For instance you could do some last minute year end spending on money earning expenses that are tax deductable to wipe out tax owing. This would be the same as getting an investment return equal to the percentage rate of your marginal tax rate.  An example of this type of expense practice for a real estate agent or broker, would be to pay the full amount in their TFSA towards advertising costs, cost of an assistant’s labour and networking events and associations.

Another potentially good plan is to recommend that your clients loan their money out as second and third mortgages and bridge financing to qualified clients.  Done properly this could make money for your clients and generate a good source of funds to assist people in financing property purchases.  Just make sure you know what you are doing and follow professional advice.

So you say…well, if I cannot reduce my taxes by contributing, I am limited in what I can invest my money in and I am limited to contributing only a small amount of money each year, why bother?

The answer is: The primary rational is that a little bit of money over a lot of years, amounts to a sizable chunk of money over the long haul.  However the best idea is to see it as a way to create a bank account dedicated to the creation of wealth.  To grow that fund and when you retire, to deposit all your money there up to your full allowable room and be able to bring that amount out without government claw backs. Also TFSAs can be used for retirement planning because the accounts could be willed to a spouse upon death, or the assets transferred to the spouse’s account.

I am not a great fan of the Harper Government, but they are earning my begrudging respect.  They do have a sensible approach to taxes and the economy.  This looks like a good move on their part.

Dan White

President

WNBC

www.wnbc.net and www.danwhite.ca

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