PLANNING FOR THE NEW YEAR - Year End Tax Planning

December 2007

As the end of the year approaches, it is time once again to turn your attention to income tax planning. If you act fast, many personal and business tax planning opportunities are available before the year-end. Whether you are in business for yourself, operate through a corporation or you are an employee, now is a good time to take stock of your tax situation and consider moves you can make before the year is out to minimize your taxes. This memo focuses on some of these tax-planning ideas.

KEY DATES

The following are key dates with regard to tax credits or deductions on your 2007 tax return along with a few other important dates:

December 15, 2007

• Final quarterly instalment of 2007 tax due for individuals.

December 24, 2007

• This is the final trading day for Canadian exchanges for which to have trades settle for 2007.

December 31, 2007

• RESP contributions (in order to get the extra 20% from the government to a maximum of $500 extra per child)
• Charitable donations
• Medical expenses
• Union dues and professional fees
• Investment counsel fees, interest and other investment expenses (including safety deposit box fees)
• Spousal support and maintenance payments
• Child care expenses
• Moving expenses
• Political contributions
• Deductible legal fees
• Tuition fees
• Payments to employer to reduce standby charge
• RRSP contributions if you turn 71 by December 31, 2007
• Advise employers if alternative operating cost benefit on employer provided automobile would be advantageous (as long as business use > 50%)
• RPP contributions

January 15, 2008

• Notify employer to defer the benefit from exercising stock options in 2007.

January 30, 2008

• Payment of interest owing on intra-family loans.
• Non-deductible interest payable by you on loans from your employer, to reduce your taxable benefit.

February 14, 2008

• Payment to your employer to reduce your taxable operating benefit from an employer provided automobile.

February 29, 2008

• Last day to make T4, T4A & T5 filings.
• Deductible contributions to your own RRSP or spousal RRSP.
• RRSP Home Buyer's Plan repayment due.

March 15, 2008

• 1st quarter (2008) personal tax instalments due.

March 31, 2008

• Last day (generally) to file Partnership Information returns.
• Last day to file inter vivos trust returns.
• Last day to file forms regarding amounts paid to non-residents.

April 30, 2008

• Last day to file personal income tax returns (except for self-employed individuals or spouses of self-employed individuals in which case the deadline is June 15, 2008). No matter your deadline, interest will be charged on any balance due after April 30.

NEW IN 2007

As always, this year there are a number of new income tax changes or proposed changes. Here are a few which may affect you:

• Federal corporate income tax rates are to be reduced from 22.12% to 18.5% (general rate) over the next four years. The small business rate falls from 13.12% to 11% over the next two years.
• Small business threshold (Federal) rose from $300,000 to $400,000 in 2007.
• Pension income can now be split.
• Lifetime capital gains exemption increased from $500,000 to $750,000 for qualifying dispositions after March 18, 2007.
• RESP lifetime contributions rises to $50,000. Annual Canada Education Savings Grant rises to $500 based on a $2,500 contribution.
• Capital cost allowance on M&P equipment increased from 30% declining balance to 50% straight line for acquisitions from March 19, 2007 to the end of 2008.

OWNER-MANAGER CONSIDERATIONS (PROPRIETORSHIPS AND/OR CORPORATIONS)

• Ensure that you calculate the Corporations General Rate Income Pool (GRIP) as at year end for purposes of dividend payments and that you determine the ordering of all dividend payments. This is still a new and extremely complicated area so please call us to discuss its impact on your organization.
• Ensure if incorporated, that you and your family maintain access to the $750,000 lifetime capital gains exemption
• Consider home office deductions
• Pay salaries to family members before year-end. If your spouse or children work for you, consider paying them salaries. Salaries paid reduce corporate income and are taxed in their hands at lower marginal tax rates than if the income had been paid to you. Any salary paid must be reasonable given the services performed. A good rule of thumb is to pay them what you would have paid a third party.
• If possible, defer income or gains until after your year-end; defer dispositions of assets until after year-end and purchase depreciable assets prior to year-end.
• It is never too soon to consider estate and will planning. We at DMCT work together with our clients and top lawyers to ensure optimum tax planning for the inevitable.
• Claim the new Federal 25% tax credit on eligible expenditures to create licensed child care space for your employees' children.
• Ensure the use of intercompany charges maximizes tax results.
• Ensure you accrue all necessary salaries and bonuses before your year-end (these must be paid within one hundred and eighty days thereafter).
• Ensure you address your shareholder loan issues (i.e. do not leave balances outstanding more than one year).
• Consider the appropriate dividend and salary mix from your corporation. This can vary based upon a number of factors, most notably the relatively new dividend tax regime.
• Fund any donation pledges in advance.
• Review your capital dividend account.
• Ensure you pay your final corporate taxes before interest charges accrue. This can occur either two or three months after year-end depending upon the income level and the nature of your corporation and any associated corporations.
• Consider how to reduce capital tax if incorporated.
• Write-off bad debts and obsolete inventory.
• Consider draft rules restricting interest deductibility. Call us to discuss.
• Does an Individual Pension Plan ("IPP") make sense for your situation?
• Ensure you take advantage as applicable, of Canada's incentive laden Scientific Research and Experimental Development programs.
• Does an Employee Profit Sharing Plan ("EPSP") make sense for your situation?

Income Splitting

• Capital gains earned by spouses are subject to the attribution rules, but capital gains earned by children are not. Shares that do not pay dividends, or specifically designed mutual funds can be gifted to any child without attribution of the eventual capital gain. Since the gains are not subject to the attribution rules, the minor children could also purchase such assets using a non-interest bearing loan from a parent.
• Parents may settle a trust for the benefit of their minor children and provide an interest bearing loan to the trust for the purchase of real estate that is rental property. If the loan carries the prescribed rate of interest, the rental income in excess of the interest expense paid to the parents can be allocated to the children without the application of the "kiddie tax", or the attribution rules. However, if the rental property is tied into the parents business, then the "kiddie tax" will apply.
• If a private company paid annual dividends to a family trust, and the trust retained the income and invested the after-tax amount, the trust could allocate investment income from after-tax dividends to the children, as long as the trustees do not invest in unlisted shares. The after-tax income is invested at the trust level and can be allocated to the children without the application of the "kiddie tax", or the attribution rules.
• Spouses and children that are not minors can receive taxable dividends from private corporations. In order to avoid the application of the attribution rules, your spouse or children, who are 18 years of age and older, should pay for the shares of your corporation at fair market value using their own funds.
• The spouse and adult children could receive dividends from the corporation out of its after-tax profits in order to split income. Also, dividends paid by the corporation before its year-end could generate a tax refund on its corporate tax return, if it has previously earned investment income on which it paid tax.
• There could be a problem with this type of planning if you have loaned or transferred property to a corporation. In this case, you must ensure that the company maintains its status as a Small Business Corporation. Otherwise, you could be subjected to an imputed interest penalty if your spouse or children are shareholders. Contact your DMCT tax advisor to discuss this matter further.
• Don't forget to split pension income as applicable.

INVESTORS

For the 2007 taxation year, 50% of capital gains are taxable. Capital losses can generally only be deducted to the extent you have realized capital gains in the year. Capital losses may also be carried back three years or forward indefinitely to offset capital gains that have been realized in other years. Review your asset sales for the year to determine your net capital gain/loss position, and consider the following planning points:

Consider Foreign Investment reporting rules

• If you invest in "offshore funds", the Foreign Investment Entity rules may apply.
• Depending upon the level of ownership and control you have of foreign corporations, the Foreign Accrual Property Income rules may apply.

Consider carry back of capital losses realized in 2007

• If you realized capital gains in the last three years (2004, 2005 or 2006) and you realized capital losses in 2007, carry the losses back against the previous years' capital gains.

Donation of Securities

• If you are making donations, consider donating marketable securities directly to the charities. The end tax result (nil capital gains tax) is preferred over selling securities and then donating cash. These rules also apply to shares received by way of employee stock options.

Consider selling investments with accrued losses before year-end/hold gainers until 2008

• If you have realized capital gains in the year or in the last three years, consider selling assets with an accrued loss to offset the gain. When making your investment decision between now and the end of the year, remember that securities transactions only take effect on the settlement date, i.e., three business days after the trade date. For a 2007 settlement, the last day for trading securities through a Canadian stock exchange is December 24. Different dates may apply for foreign exchanges (consult your broker). Delay selling assets with inherent gains until 2008.

Beware of superficial loss rules

• The superficial loss rules prevent a taxpayer from claiming a capital loss on an asset that the taxpayer clearly intended to continue to hold. If you are holding an asset with an accrued loss and wish to sell the asset to offset against any capital gains realized, and you purchase an identical asset within thirty days either before or after selling the original asset, these rules will apply to deny the capital loss, provided that the asset is held at the end of thirty days after the sale. The superficial loss rules would also apply if your spouse buys the asset within the thirty-day period and even if you or your spouse has a controlled company that does so.

Claim the $750,000 Capital Gains Exemption

• Small business corporation shares still qualify for the lifetime capital gains exemption. If you have already claimed the $100,000 personal capital gains exemption (abolished in 1994), you can only claim an exemption up to $650,000. If you plan to use your exemption in 2007 check whether you have realized business investment losses in prior years or have cumulative net investment losses at December 31, 2007, as these will be taken into account and you may not be able to claim the full exemption. Also, depending upon your income level for the year there may be Alternative Minimum Tax Consequences ("AMT").

Business Investment Loss ("BIL")

• A BIL can be used to reduce income from all sources. In fact, where capital losses can only be used to reduce capital gains, 50% of a BIL (commonly known as an Allowable Business Investment Loss, or "ABIL") can be used to reduce your overall income. Therefore, if you are a shareholder or creditor of a financially unstable private corporation, consider selling your shares or debt to an unrelated person before December 31 to realize an ABIL for 2007. Remember, however, that if you have already claimed a capital gains exemption in the past, the amount if the ABIL is reduced by the claimed amount.

Foreign Exchange

• Ensure you take into account the fluctuation in foreign exchange rates when calculating gains and losses. You may for instance have made money in the originating currency and lost money in $CDN.

Resident and Non-Resident Trust/Foreign Investing

• The rules regarding Canadian and foreign trusts as well as those relating to foreign investments are extremely complex and ever changing. Contact your DMCT tax advisor if you feel you may fall into this category.

Interest

• Ensure you pay off non-deductible debt before deductible debt.
• The rules regarding interest deductibility are ever changing with a multitude of new rules under draft legislation effective for 2005 and beyond. If you are deducting interest in anything but the most straightforward situation, please contact your DMCT tax advisor to discuss the matter.

Capital Gains Rollover

• Several of our clients have disposed of the shares of eligible small businesses in 2007. A subsequent investment in an eligible small business by April 29, 2008 could defer all or a portion of the initial gain. Please call us to discuss the intricacies of this planning alternative.

United States Estate Tax

• If you hold property in the U.S. make sure you speak to us about potential estate tax issues.
• If you have ties to the United States, we work closely with our Nexia USA affiliates to achieve optimal planning.

EMPLOYEES

• Company cars are always considered a perk of employment. However, the perk carries with it tax issues. You can reduce your operating cost benefit by minimizing personal driving and/or by reimbursing your employer for the personal use portion of your actual costs.
• You can reduce your standby charge by reducing your personal driving or by purchasing the car from the employer (especially if it is an older vehicle).
• Remember to claim the G.S.T. rebate as applicable.
• Consider your eligibility for home office deductions.
• If you anticipate a bonus at year-end and expect lower taxable income in 2008 (i.e. maybe you will be taking maternity or parental leave), try and defer that bonus until 2008 to lower the tax impact.
• Ensure you take advantage of potential stock option deferrals as applicable.
• As applicable, ensure that all matters pertaining to taxation of any employee loan you have received are dealt with appropriately.
• Ensure you keep your public transit passes to obtain tax credits.

MOMS AND DADS

• Make sure that if you have children under six, you are registered for the Universal Child Care Benefit available to all families, regardless of income.
• Don't forget to contribute to your kids' RESPs. Apart from the obvious benefits, the government will add to your contribution up to $500/yr to a maximum of $7,200 lifetime.
• If applicable, take advantage of the adoption tax credit.
• Ensure that you round up all camp and childcare receipts (paid).
• Make sure you have tuition receipts from your kids which you can utilize if they can not use.
• Make sure you keep receipts for childrens sports/fitness classes for classes taken in 2007 in order to benefit from new tax credits.
• Don't forget the new $2,000 Federal Child Tax Credit.

RRSP'S

• If you have not contributed to your RRSP for the year yet, you should do so now. For 2007, you can claim an RRSP contribution of up to 18% of income earned primarily from employment, business or the rental of real property in 2006, up to a maximum of $19,000, subject to pension adjustments and pension adjustment reversals. Your contribution must be made on or before February 29, 2008 to be deductible for 2007. You are allowed to make an excess contribution of $2,000 without being subject to tax. Consider the following additional RRSP planning points.

Unused RRSP contribution room

• If you contributed less than the maximum allowable amount to your RRSP in a previous year, use the unused RRSP contribution room for 2007 by contributing an additional amount equal to the unused room, if you can afford it. If you decide not to contribute for 2007, your ability to do so carries forward indefinitely. However, even if you don't need the deduction for 2007, you should still make the contribution if you have excess funds, which would otherwise earn taxable income in your hands. You can claim the deduction in any future year. The income from the funds will accumulate tax-free in your RRSP.

Maximize 2008 contribution

• If you have some control over your income level, ensure that it's high enough to allow the maximum RRSP contribution. For instance, if you carry on a business through a corporation, ensure that your 2007 salary is at least $112,000, to allow a full $20,000 contribution in 2008. If you have excess investment funds, make your RRSP contribution for next year as soon after December 31st as possible, to maximize the deferral of income earned in the plan.

Consider borrowing to make a contribution

• Although the interest paid on funds borrowed to make an RRSP contribution is not deductible, borrowing to make a contribution may be advantageous if you can repay the loan within a year. If you do borrow, make sure that earnings within your RRSP are growing at a faster rate than your interest payments. If you receive a tax refund, you can and should apply it to the loan to reduce the balance outstanding.

Turning 71 in 2007

• If you turn 71 in 2007, you will have to terminate your RRSP by December 31, 2007. You will need to make your 2007 contributions before that date (not February 29, 2008). It is extremely important not to wait until the last minute to plan for your RRSP maturing. If you do not make a decision as to how you wish to receive your retirement income by December 31, the full market value of your RRSP will be added to your taxable income in 2008. There are many options available, including transferring your RRSP to a Registered Retirement Income Fund ("RRIF"), receiving an annuity, receiving a lump sum, or choosing a combination of these options to create the best financial plan for your retirement needs. If your spouse is not over 71 and you still have earned income, you can continue to contribute to your spouse's RRSP and claim the deduction on your own tax return. If you have income in 2007, you could make a 2008 contribution to your RRSP (by December 31, 2007). There will be a small penalty for this early over-contribution but you will then get the deduction one last time in 2008.

TAX RATES

See the Appendices to this Article.

We hope you find these tax planning ideas useful. Many of them can be easily implemented, with little or no cost of administration. Others are more complicated and will require professional advice. If you need assistance with your year-end tax planning, contact your DMCT advisor.

APPENDIX A

Top Combined Marginal Personal Income Tax Rates

APPENDIX B

Combined Corporate Income Tax Rates for All Corporations

(Based on a December 31 year end - please note that in the case of a Canadian Controlled Private Corporation, this Appendix does not generally apply to the first $400,000 of active business income nor does it apply to investment income).

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