The Four D's of Tax Planning.......

by Jeffery A. Keill, CFP, CIM, FMA, FCSI, Portfolio Manager and Wealth Advisor Keill and Associates- Advisory Team

Canada’s Income Tax Act

(RSC1985-5th Supplement) Part 1 Income Tax, Division A- Liability for Tax, 2.(1)

“An income tax shall be paid, as required by this Act, on the taxable income of each taxation year of every person resident in Canada at any time in the year.”

With that statement so opens a can of worms. Just look at all the questions that beg to be asked: What tax? What rate? What is taxable income? What is income? What is a taxation year? This is what has led to our cumbersome tax environment. Since we Canadians are used to watching sap boil for hours we are genetically developed with the ability to spend time asking these questions.

Jean Baptiste Colbert, Minister of Finance under King Louis of France once said, “The art of taxation consists in so plucking the goose as to obtain the largest possible number of feathers with the smallest possible amount of hissing”. Canadian politicians would probably agree with Mr. Colbert.

Taxation has always been a hot button for many Canadians either on the amount of the levy or it’s use. There has been endless debates about it’s  collections and it’s management. So what can individual Canadian taxpayers do to legally lesson their tax bite?

Well to start with, it helps if you understand and appreciate the basic concepts hidden behind the wall of tax talk. The overall scheme is really not complicated and is a good place to start.

Understanding the Tax System

Progressive System: The Canadian income tax system is said to be a “progressive” system of taxing income of those deemed to be a resident in Canada (although many find humor in the “progressive” statement). The system in Canada is made up of a series of progressive taxable income rates or “brackets”. Each bracket applies a higher rate of tax, as income levels get larger. The higher the taxpayer’s income the greater the rate of tax on each additional dollar they earn.

Example of a Combined Marginal Tax Rate Brackets

                   Taxable Income                               Tax Rate

                      $0 to $10,000                                    0%

                      $10,001 to $35,000                         20%

                      $35,001 to $65,000                         30%

                      $65,001 to $100,000                       40%

                      Greater than 100.001                    45%

One misconception many Canadian’s have is if you were to increase your taxable income to an amount that puts you into the next tax bracket all your income would get taxed at the higher rate. This is simply not true. Only the dollars that fall within the higher tax bracket get taxed there. Based on the simplified table above, someone with a $35,000 income would be taxed 0% for any income under $10,000, and only the income between $10,001, and  $35,000 is taxed 20%.

Total Income: The calculation of tax liability starts with the summation of all income. The interesting point about our system is that not all income is taxed equally. Income from employment, interest, and net rents are generally fully taxed; whereas, dividends and capital gains are considered to be tax preferred. By favoring different forms of income the government can persuade the tax payer to invest back into Canada and take ownership in assets that would better the Canadian economy. This tax preferred income leads to smaller tax liability for each dollar of investment return.

System of Deductions and Credits: The second basic step in calculating Taxable Income is to apply possible deductions against the taxpayer’s income. If tax is applied on a taxpayer’s taxable income, reducing the taxable amount of income will reduce the over all tax liability. There are a whole series of deductions that Canadian’s must consider.

The next steps after applying the tax rates to Taxable Income (which gives us the Basic Tax) is to calculate those Tax Credits that will reduce the actual tax dollars owed directly. The most common are the Non- refundable Tax Credits, which will reduce your tax owing to zero but not beyond (hence: non-refundable).

The Four D’s of Tax Planning

In light of the system that Canadian taxpayers are working within, there are simple concepts to keep in mind when trying to reduce your income tax bill. These are the 4 D’s of Tax Planning: Defer, Divide. Deduct and lastly Don’t Declare. (I know there actually 5 D’s!)

Defer: ‘Why pay today what you can put off until tomorrow”. In other words, a dollar spent on tax tomorrow is worth less then the same dollar today if we consider ‘time value of money’ and the impact of inflation and investment returns. If we can find a way to have the tax applied on the same dollar at a later date then that could be favorable Common deferral methods are using an RRSP or avoiding realized capital gains.

Divide: The concept of dividing income to reduce taxes is simply based on having dollars taxed at lower marginal rates and attracting missed tax credits. For example, it would be better to have a $100,000 family income taxed evenly in the hands of both husband and wife ($50,000 each), then it would be to only have it taxed in the hands of only one. When you do this “splitting” of income you attract personal tax credits and bring taxable dollars back down into lower marginal rates. Unfortunately, attribution rules exist to limit the ability of individuals to take advantage of this tax strategy.

Deduct: Since the taxing of our income is based on the level of the income, it makes sense that we can reduce our income, we therefore reduce the amount of tax. This idea behind electing to deduct certain transactions for taxes. For example, when we elect to make a RRSP contribution or pay the cost of daycare, we may have the possibility of reducing our taxable income by that same dollar amount.

Don’t Declare: Even though one strategy is to not declare income, it is a very stupid strategy as it is completely illegal and can result in tremendous fines and possible imprisonment. The tax act requires the reporting of all worldwide income if you are deemed a resident of Canada. There is a difference between “evasion” and “avoidance”. Taxpayers ought to ensure they ‘avoid” paying unnecessary taxes by arranging their affairs legally but never evade.

Disclaimer: This document is a simple overview of the tax strategies to help individuals legally reduce the amount they would have to pay. It is not intended, nor should be, constructed as individual advice. If you would like more information about the topics covered in this Discussion Paper, please contact our office. It is important that individuals consult a tax professional before deciding on the implementation of any personalized strategy.

Last Edit Feb 4, 2025