Investments & Taxes - What You Need To Know

Choosing the right investment vehicle for your needs involves careful consideration of many different variables. You've examined the risk, the return, the flexibility and cost and then there's taxation. Believe it or not, taxes can have a significant impact on the, overall performance of your investment program. While they need not form the basis of your investment decision, it is important to understand how taxation can make a difference.

To understand how you can achieve tax smart returns with your investment program, you must be aware of two fundamental principles:

    1) Different tax regulations apply to different types of income, and
    2) The rate at which you pay tax depends on your income and can vary from province to province.

Canada uses a progressive system for taxation, whereby the rate of tax increases as the individual's taxable income increases. By varying your investment income mix and by being aware of the tax bracket you are in, you may be able to not only maximize your investment return, but maximize the investment return you get to keep.

There are four basic sources of investment income: interest, foreign income, dividends and capital gains. Each source is taxed differently. Consequently, the amount of income that is attributed to any one source affects both how much tax you will pay and the overall return earned on your investments.


Interest income along with your regular income from business or employment is subject to the highest taxes of all types of income. This includes all income earned from bank accounts and from fixed income investments such as guaranteed investment certificates (GIC's), Canada Savings Bonds and government Treasury bills.

Foreign income is generated when you hold securities or invest in a fund that holds securities from a non-Canadian issuer that earns dividend or interest income. Foreign income is fully taxable to Canadian investors. If foreign tax is withheld before the income is reinvested in the fund, investors may receive a foreign tax credit.



You receive dividend income if you are a shareholder in a corporation, or if you invest in a segregated or mutual investment fund that owns shares in a corporation paying dividends. Dividends are paid out of a corporation's after-tax income. To avoid double taxation, dividends paid from a Canadian corporation qualify for dividend tax credits. These credits offset both the federal and provincial tax payable, making dividends a very tax-efficient source of income for most Canadian investors.

Capital gains are generated when the value of an asset increases from its purchase price. The gain is not taxable until it is realized. Capital gains are realized in one of two situations: when the investor sells the investment, or in the case of a professionally managed investment fund, when the money manager sells a security at a profit. Once realized, three-quarters of the gain is taxable. Realized capital losses occur when the investment is sold at a loss. Capital losses can be used to offset gains. If losses exceed gains in any one year, you can carry back the loss to offset gains made in the three previous years or carry forward the loss indefinitely.    

Comparing Interest Income, Dividend  Income & Capital Gains

1) To calculate taxable income., dividend income is grossed up by 25%. Interest income is 100% taxable. 75% of realized capital gains are taxable.
(2) Federal taxes on interest income and realized gains are calculated as 26% of tax- income. Federal taxes on dividend income are reduced by dividend tax credits. The credits are equal to 13.33% of the dividend gross-up.

If you invest in your own personal portfolio of securities, you maintain complete control over which types of investments you will hold and how long you will hold them. You will be responsible for keeping accurate records for Revenue Canada and for documenting the income received by the investment along with any taxable gains.

Investing in a fund provides investors with a more diversified approach. Because the fund is managed by a professional money manager, individual investors do not control which specific investments are bought and when they are sold. The fund company sponsor generally looks after all of the paperwork documenting the sources of income accrued to each individual investor.

Investment funds distribute income earned after expenses to its individual investors who are then taxed it their own marginal tax rates. Generally, income distributed by segregated investment funds issued by Canadian life insurance companies and mutual funds set up as trusts retains its original identity.

    For example, if a Canadian equity fund earns dividend income and capital gains, the income earned
    by the individual investors will be dividend income and capital gains. Below is an example of the
    T3 Supplementary Form that reports income earned for non registered investments held within a plan:



T5 slips are used to report interest income for investors holding GIC investments.

Maximize investment returns. Growing and preserving your estate.

Whatever your goals, the strategies outlined following can help identify ways to accomplish them more tax efficiently. Because the benefits for each strategy depend on your personal circumstance, it is important to talk to your financial advisor to discuss which ones best fit your overall plan.

I don't know what the Seven Wonders of the World are but I know that the Eighth Wonder is: Compound Interest

1. Maximize RRSP contributions

RRSPs are tax-sheltered, which means any investment income earned will grow at a faster rate than money invested outside the plan. There are two primary RRSP benefits: tax deferral and tax sheltering.

Tax Deferrals Reduce Taxable Income

By contributing to an RRSP, you defer some of "today's" income until your retirement. By deferring the income, you obtain an immediate tax deduction for the amount invested. Assuming a marginal tax rate of 50%, tax sheltering $5,000 within an RRSP is the equivalent of investing $10,000 outside an RRSP.

Tax-Sheltered Income

In addition to reducing your taxable income, another important advantage of RRSPs is they provide tax-sheltered growth. Any income earned by investments held within an RRSP is not taxable until withdrawn from the plan. Over an individual's working career, tax-sheltered growth results in a significant investment advantage.


 The graph shows the compound growth of a $10,000 deposit to an RRSP and a non-registered vehicle like a savings account using a 10% annualized return and a marginal tax rate of 50%.


Any Canadian resident who is under age 69 and has qualified earned income is eligible to contribute an RRSP

RRSP Contribution Limits