Have you been able to sock away investment money and take advantage of the recent boom in the global economy? As the worldwide shutdowns necessitated by the initial outbreak of COVID-19 have eased, companies in a variety of sectors have seen their profits soar. Costs of materials are increasing, and manufacturers are increasing their prices by even more than the cost increases, which means profits – and share values – are moving up.

More money in your investment account is a good thing. However, if you invest in a non-registered account (or a taxable account) and your gain hit 10 percent last year, you have a tax liability for those gains.

In this article, we will look at the various taxation methods on four types of investment income. Dividends, interest, and capital gains are all taxed differently, so let’s look at how each one works.

Amansad Financial does not provide tax advice; this article is purely informational. Please consult a professional tax accountant before making investments.

Dividend taxation

Canadian Dividends and Foreign Dividends are taxes differently. Dividends from Foreign countries is ordinary income and the Canadian Revenue Agency taxes accordingly. The dividends from Canadian Banks fall into two categories: eligible and non-eligible. Eligible dividend income has a lower rate than non-eligible dividends. Both rates are lower than ordinary income tax rates.

Interest income taxation

Canadian law taxes interest income at your highest marginal tax rate. If you have an 8 percent bond, that bond will yield you $8 in interest each year. If your taxable salary is $100,000, then your marginal tax rate is about 45 percent. That means you would owe $3.60 on that $8. That’s a substantial chunk out of your investment profit. This means that you should move more money into your registered, or non-taxable, investment accounts. Interest income on Arm’s Length Private Mortgages can either be funded within or outside of a registered account of a qualified Trust Company.

Capital gains taxation

Of the three types of investments, this has the lowest tax liability. Let’s say you purchase ten shares of a company for $1,000. You go back and sell those shares for $1,250. Your capital gain is $250. Only half of that gain is taxable income. Remember that 45 percent marginal tax rate from earlier? It applies to $125 (half of your gain), so your tax on that $250 of capital gains is just $56.25.

If you have an ETF (exchange-traded fund) or a mutual fund, either of those can pay dividends, interest, capital gains or a combination of the three. These two funds are securities baskets, so a return of capital is another form of payment that they can use.

A return of capital works like a capital gain. So, let’s say you buy ten shares in a mutual fund for $100. Then, the mutual fund gives you back $30 in capital. Now your cost is $70. Now, if you sell those shares for $150, your capital gain is $80, rather than $50. You would pay the 45 percent tax rate on half of that $80 gain, or $40. Your tax liability would be $18 in that instance.

Foreign withholding taxes

As a Canadian resident, you must pay taxes on income you earn, no matter where the business activity took place. The T1135 Foreign Income Verification Statement tells the CRA your foreign income and assets. If you have international investments, the withholding tax on the dividends or interest can reach as high as 30 percent. This is to ensure that the CRA receives the applicable taxes.

If your investment is with a US-based company, the tax treaty between the two countries often puts the withholding tax between zero and 15 percent on the interest and the dividend, respectively. The W-8BEN form is necessary to get this break. Without that form, you would have to pay to have a U.S. non-resident alien tax return prepared, which is often more expensive than the refund.

Any investment bears risk, and non-government-backed investments can fluctuate significantly. When times are good, this can also lead to tax implications that investors do not always remember to consider. It is important to understand the tax implications of any investment before placing your money.

If you have an ETF (exchange-traded fund) or a mutual fund, either of those can pay dividends, interest, capital gains or some combination of the three. These two funds are securities baskets, so a return of capital is another form of payment that they can use.

A return of capital works like a capital gain. So, let’s say you buy ten shares in a mutual fund for $100. Then, the mutual fund gives you back $30 in capital. Now your cost is $70. Now, if you sell those shares for $150, your capital gain is $80, rather than $50. You would pay the 45 percent tax rate on half of that $80 gain, or $40. Your tax liability would be $18 in that instance.

Foreign withholding taxes

As a Canadian resident, you must pay taxes on income you earn, no matter where in the world the business activity took place. The T1135 Foreign Income Verification Statement tells the CRA your foreign income and assets. If you have international investments, the withholding tax on the dividends or interest can reach as high as 30 percent. This is to ensure that the CRA gets the applicable taxes before the income is paid.

If your investment is with a US-based company, the tax treaty between the two countries often puts the withholding tax between zero and 15 percent on the interest and the dividend, respectively. The W-8BEN form is necessary to get this break. Without that form, you would have to pay to have a U.S. non-resident alien tax return prepared, which is often more expensive than the refund.

Any investment bears risk, and investments that are not government-backed can fluctuate significantly. When times are good, this can also lead to tax implications that some investors do not always remember to consider. It is important to understand the tax implications of any investment before placing your money.

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