The third Liberal budget was presented on February 27, 2018. It focused mainly on innovation, skill development and gender equality. However a few measures also impact investors and business owners.

Personal Measures

Despite much speculation, the capital gains inclusion rate remains at 50%.

CRA Funding: To combat tax evasion and tax avoidance, the government will invest $90 million over five years to target non-compliance in high risk areas including individuals with offshore accounts.

Reporting requirement for Trusts: Starting in 2021 and subsequent years, trusts will be required to report the identity of all trustees, beneficiaries and settlors. This will create a filing obligation for certain trusts where one does not currently exist. Penalties for failure to file will be $25/day with a minimum of $100 and a maximum of $2,500. Gross negligence penalties could be as high as 5% of the maximum fair market value of trust property held in the year.

Small Business Owners

Small business tax rate: A private corporation currently pays tax at 10.5% on its first $500,000 of active business income. The government confirmed it will proceed with lowering the small business tax rate to 10% starting January 1, 2018 and to 9% starting January 1, 2019. Tax rates on non-eligible dividends will be increased accordingly.

Passive investments: New rules have been introduced to limit the ability of earning passive investment income inside a corporation. Effective for tax years starting after 2018, if a private corporation (or its associated corporations) earn more than $50,000 of “aggregate investment income” it will see a grind on the $500,000 federal small business limit. The small business limit will be reduced by five dollars for every dollar of investment income in excess of $50,000. Thus will be fully eliminated once passive income exceeds $150,000.

The “Aggregate Investment Income” used in the calculation will not include capital gains on the sale of active business assets or shares of qualifying small business corporation (or certain partnerships that meet tests similar to those of a qualifying small business corporation). Net capital losses from other tax years will not be considered in the calculation but taxable dividends form non-connected corporations and investment income from non-exempt life insurance policy will increase “aggregate investment income”.

A second refundable dividend tax on hand (RDTOH) account will be created. The first RDTOH account will keep track of refundable tax on investment income and the second will keep track of refundable tax on portfolio dividends from Canadian corporations. A private corporation will no longer be able to pay eligible dividends to recover refundable tax on investment income. Instead, only non-eligible dividends will recover refundable tax on investment income. Only once that RDTOH account is depleted will the corporation be able to pay eligible dividends to recover refundable tax on Canadian portfolio dividends.

Income Sprinkling: The government confirmed its intention to proceed with the “income sprinkling” measures announced on December 13, 2017. These rules are effective for 2018, meaning that paying dividends to certain family members may no longer be an effective strategy of reducing a family’s overall tax burden.

Clearly some big changes for business owners as none of the new measures included grandfathering as was previously expected. We will be happy to meet with you to review and discuss your current passive holdings and how your small business deduction or investment strategy may be impacted.

Rob Tétrault, B.A., J.D., MBA, CIM
Senior VP and Portfolio Manager

Cedric Paquin, CPA, CA, CFP
Wealth Planning Consultant

1. Education and Credentials.

Inquire with CSA (Canadian Securities Administrators) and look for registration of the investment advisor or wealth management firm in question. Ask the advisor about his experience in the industry and his credentials (CFP, CIM, MBA, etc.). In order to keep their designation, advisors must adhere and follow the rules from their employer’s ethics policy and are obliged to complete continuing education requirements. Look for an investment advisor from a top reputable wealth advisory group with specific credentials and who is willing and ready to assist you with your objectives and needs in portfolio management.

2. Compensation.

Carefully choose an investment advisor with a pay structure tailored to your needs. An as investor, you have the option to pick an advisor who earns their income via hourly work, a fee based on assets under management or via compensation by means of transaction commission fees.

A fee based investment advisor gets compensated by charging a percentage fee on the overall amount of assets under management. This means, a higher amount of savings in someone’s portfolio equals greater pay for the advisor. Keep in mind, the fee charged to clients by the wealth management firm may also lower when the total of assets increases and reaches a target threshold (Eg. Fee of 1.5% for +$500,000 and 1.25% for +1,000,000 in assets under management). Fees may vary depending on the advisor or wealth advisory group chosen to manage your investment portfolio.

On the other hand, advisors who are compensated via transactions commissions will collect a commission fee for every executed trade. In addition to having the overall assets under management grow in the client’s portfolio, the latter will benefit from trading securities as he or she receives commissions on the transactions taking place within the client’s portfolio.

Before going on the hunt to find an investment advisor or a wealth management group to work with, you will want to determine your financial goals and needs and the compensation method of the securities expert you are willing to team up with.

3. Discretionary or Non-Discretionary.

Ask your investment advisor if he/she runs their practice with discretionary or non-discretionary management.

What is discretionary management? Certain investment advisors may qualify as portfolio managers able to act on a discretionary basis, subject to certain criteria. If an investment advisor trades securities for his or her clients under a discretionary portfolio management model, the former trades securities as he or she sees fit for their client’s portfolio without the need of the client’s approval. In other words, discretionary portfolio managers will not require your permission to trade equities on the global financial and stock markets. The discretionary model works best when trust has been established in the relationship between the investor and the advisor.

Whereas, if you are dealing with an investment advisor under a non-discretionary model, keep in mind that the he or she will need to confirm with their clients before executing a trade. Your approval will be needed before the trade of a security takes place on the financial markets. This is a preferable scenario if the investor wants to be kept in the loop before trades are executed in his or her portfolio.

4. Minimum Requirements.

Some investment advisors only work with clients who can meet the minimum target of assets and savings to invest. In your search for a wealth management firm or an independent advisor, focus on looking for a professional who will make time for your concerns, questions and is interested in building a long term relationship. Be aware that some advisors require minimums and you should make sure to do some due diligence to determine if you’re a good fit with the investment management firm or independent advisor you are inquiring about.

5. Marketing, Social Media & Website.

How prominent is the brand presence in your area? Do you see the advisor’s brand name in local newspapers, online advertisements, local news, etc.? Is the wealth management firm’s brand mentioned and present on the radio, television and online communities?

Be aware that wealth advisory firms do differ in size and service offerings. Marketing budgets are usually correlated with the size of the firm or boutique, but this is not always the case. One could possibly evaluate a wealth management group’s marketing and brand presence in comparison to the size of the financial institution or boutique shop someone is inquiring about. Long-term branding omni-presence is often considered a sign of a successful marketing campaign. Most successful independent advisors and wealth management firms will promote and advertise their professionalism, exceptional customer service, competency and integrity in their respective practice.

Does the advisor have a LinkedIn Profile? Maybe a Twitter or Instagram account? Does he or she create and put out content videos on YouTube? Is the website layout clean, sharp and professional? Does the advisor have a financial blog? Online brand presence has never been more important in today’s business marketing plans. More and more folks like you go on-line to read, research and do the research necessary in order to make a smart, educated and calculated decision with respect to whom they choose to work with. Online brand exposure is imperative for achieving success in many other business sectors as much as it is for the top investment advisors and the best wealth management groups in your local area. The trend of searching and gathering online information on business services and offerings has never been more popular worldwide.

6. Community and Charity Involvement.

Look for an investment advisor that is passionate about making a difference in their local community. Philanthropists strive to make this world a better place by creating & founding charity programs, volunteering their time to community events and/or donating their hard-earned money to worthy causes. Advisors who have the local residents and their community’s best interests at heart reveals a lot about their respective personality, character and life priorities.

Leadership, generosity and empathy are common philanthropist personality traits. They genuinely care for other people’s well-being and aim to make positive changes to their local surrounding area. Most of them strive to give back as much as they can to their community, whether it be via monetary contributions to charities & community events, volunteering their time to help out with community service, sponsoring local sports organizations and much more. By the kindness and generosity of their actions, philanthropists and community engaged advisors will most likely be more trustworthy with your hard earned money in portfolio management. They generally want the best for everyone, especially for their loyal clients.

7. Reviews, Testimonials, Endorsements & References

If you know nothing or very little about the wealth management firm’s services, team members, work ethic and track record, no need to worry. Simply search for reviews, testimonials and endorsements online about the firm or the investment advisor you are inquiring about.

Yellowpages.com and yelp.com are two of the many online directories that also have a review section for financial services and investment advisors. Endorsements can be found on either the advisor’s website or on social media. LinkedIn has a section dedicated specifically for people to endorse other folks’ abilities by clicking the + sign beside the respective skill and expertise. Evidently, you want to look for numerous positive endorsements on the advisor’s LinkedIn profile page. Many positive reviews usually confirms and testifies the skills & aptitudes of the financial advisory group in question.

Don’t hesitate to ask the wealth management team for references, preferably from people you might know locally in your community. If the individuals from the firm are confident in their money management skills and they genuinely want to help others reach their financial goals, they should have no problem giving you a list of references for you to contact. An extensive list of respected references will significantly help build a rapport & mutual trust in what will hopefully be a great and long-lasting relationship with your potential wealth management group.

8. Product Offering

Not all investment advisors can provide the same financial products and services. Investment advisors licensed through IIROC (Investment Industry Regulatory Organization of Canada) may have different investment products than a mutual fund dealer licensed through MFDA (Mutual Fund Dealers Association) and vice versa.

Clients can invest in several financial instruments in many different investment savings vehicles. Look for products that would fit your needs and financial objectives.

The use of specific products and accounts utilized by institutional clients, charitable organizations, non-profit entities, foundations, trusts, corporations, businesses, families and individuals will vary from their respective investment portfolios.

9. Services Offered: Tax, Insurance, Investment, Retirement & Estate Planning

Beware that not all investment advisors have the same service offering. Simplify your life and save yourself some precious time by working with a wealth management firm that offers more than one service. The most proficient advisors usually offer a one stop shop for a wide range of services included in their practice. Some of the services offered are: tax planning, insurance planning, estate and retirement planning in addition to investment portfolio management.

The extra service offerings mentioned above are usually included with the remuneration paid to the fee-based investment advisor for managing your assets. There are several advantages of having one firm look after all your needs. A client would be better off having the same professional advisor look after all their planning needs since the relationship has already been established and the advisor is already aware of the client’s personal constraints, objectives and financial goals.

On July 18, 2017, the federal government announced its intention to eliminate a number of tax planning strategies commonly used by small business owners. The proposed changes were widely contested and subsequently revised on October 16, 2017. The revisions included promises to simplify the proposal on income sprinkling and to provide draft legislation by the Fall of 2017.

Details were released on December 13, 2017 along with confirmation they will take effect in 2018. The “kiddie tax” will be expanded to include dividends paid to spouses and adult children that do not fall within any of the exclusions and do not meet a reasonability test.

Exclusions:

• Dividends paid to a spouse will be excluded from the new rules provided the business owner meaningfully contributed to the business and is aged 65 or over,
• Dividends paid to adults aged 18 or over will be excluded from the new rules provided the individual made a substantial labor contribution (generally, an average of 20 hours per week) to the business during the year or in any of the 5 previous years (the 5 previous years do not need to be consecutive). If the business is seasonal, the labour contribution requirement will only be applied for the part of the year in which the business operates. Records such as timesheets, schedules, log books or information contained in the payroll records will be used to establish the number of hours the individual worked in any given year,
• Dividends paid to adults aged 25 or over will be excluded from the new rules provided the adult owns at least 10% or more (measured in votes and value) of a corporation that earns less than 90% of its income from the provision of services and is not a professional corporation,
• Generally, the measures will not limit access to the lifetime capital gains exemption,

Reasonability test

For individuals between the ages of 18 and 24, dividends received must represent a reasonable return on property contributed to the business. The reasonableness criteria include:

• “Safe Harbour Capital Return”: the return on property contributed to the business will be reasonable provided it does not exceed a prescribed returned determined by a formula, and
• “Arm’s Length Capital”: the property contributed cannot be property derived from property income of a related business, borrowed under a loan or transferred from a related person.

For individuals aged 25 or over, payments that are reasonable based on the following criteria:

• Work performed in support of the business
• Property contributed directly or indirectly to the business
• Risk assumed in respect of the business
• Amounts paid or payable by any person or partnership to or for the benefit of the individual in respect of the business; and
• Other factors that may be relevant

Where an individual acquired property as a consequence of the death of another individual, special rules will apply for determining whether a dividend is excluded or reasonable or is a taxable capital gain from the disposition of excluded shares. 

Next Steps

Dividends paid to family members in 2018 and subsequent years that do not meet the “excluded” or “reasonableness” test will be taxed at the highest marginal tax rate.  We recommend that you speak to your professional tax advisor regarding paying dividends to family members prior to the end of the year.

The government has also confirmed its intention to limit tax deferral opportunities by retaining passive investments inside of a corporate. However, details will only be released in the 2018 Federal Budget.

We will continue to keep you informed of changes as they occur.

Cedric Paquin, CPA, CA, CFP
Wealth Planning Consultant

National Bank Financial is an indirect wholly-owned subsidiary of National Bank of Canada. The National Bank of Canada is a public company listed on the Toronto Stock Exchange (NA: TSX). The particulars contained herein were obtained from sources we believe to be reliable, but are not guaranteed by us and may be incomplete. The opinions expressed herein do not necessarily reflect those of National Bank Financial.

The concept of wealth preservation and the discussions that surround that concept usually happen with my clients either at or approaching retirement. Generally it’s a discussion that also happens concurrently with a risk tolerance analysis, but that doesn’t need to be the case. For example an advisor who’s hearing a young couple saying they want to preserve capital might confuse that with a conservative risk tolerance. Although that may be the case, it’s also quite possible that the client has a significant risk tolerance in the purest form of the discussion equity/fixed income ratio, but still wants to preserve wealth using defensive equity strategies. That client may have a need for higher returns, and a desire to preserve capital, and it may not be necessary, depending on risk tolerance, to move to a fixed income portfolio.  In other words, preservation of wealth and risk tolerance are not the same thing, and most advisors will often interchange the two. Assuming the discussion is actually one of preserving wealth, and not one of reducing risk tolerance, the below factors apply.

The preservation of wealth discussion usually happens at the late stages of saving or in the retirement years for most clients because that’s when they start drawing on their income or are starting to think about it. The easiest way to move to a preservation of wealth strategy is to change the asset allocation in a portfolio and to increase the fixed income component. The problem with that solution is that forces the client to be willing to accept reduced returns, and most people can’t afford that. In reality, in my view, there are better ways to do it without sacrificing returns.

Staying away from speculative stocks and sectors. This is a fairly simple and obvious one, but if investors want to preserve capital, they should stay away from speculative sectors, stocks that aren’t profitable, stocks that are trading a crazy multiples, and stocks that haven’t yet clarified or explained what their revenue model will eventually look like. Many of the pure growth plays in the markets would have these characteristics. If you can’t explain how your company is going to make money, if you aren’t currently making money, or if you don’t have a plan on how to monetize your idea, it’s probably best to stay away if preservation of capital is important. In this case, I would suggest sticking to sectors that have proven long term track records of generating profits and sustained growth, along with a slowly increasing dividend.

Replacing higher Beta equities with lower beta equities. Generally, this would be equivalent to replacing growth equities with dividend paying equities. For example, there’s an index that exists called the TSX Low Volatility index, and it targets the 50 stocks in Canada that have the lowest volatility. Not only has it historically done as good or better than the larger TSX index, but it has done it with less volatility. In theory, the way it protects wealth is that if ever there’s a market correction, the stocks should drop less than the broader index.

Adding Real assets to the portfolio. Specifically, REITs and Infrastructure are two sectors that I’ve liked for a long time. Real assets typically don’t correct as much in downturns, and provide consistent tax efficient income. If you actually take a step back and think about what you actually own when investing in these types of companies, you own actual buildings or infrastructure projects with proven long term cash flows. I always ask myself, in 20 years, what will my asset look like, and generally when considering these types of investments, they look good and have a strong likelihood of having kept its value.

Using alternatives such as Equity Linked GICs. This would be for a client who wants to have equity exposure while having the comfort of the guarantee associated with GICs. Clients can participate in the upside of the markets while having 100% of their principle protected. An easy way to preserve capital is to have the entire amount protected, and this allows for that.

Using a consistent rebalancing strategy. This is another oldie but goodie, and a simple way to protect capital. Every time the market rallies and your asset allocation get out of whack, by rebalancing, you take some profits off the table, reduce your exposure to markets, and protect yourself in the event of a market correction.

National Bank Financial is an indirect wholly-owned subsidiary of National Bank of Canada. The National Bank of Canada is a public company listed on the Toronto Stock Exchange (NA: TSX). The particulars contained herein were obtained from sources we believe to be reliable, but are not guaranteed by us and may be incomplete. The opinions expressed herein do not necessarily reflect those of National Bank Financial.