March 2001 volume 5, issue 1 

The year 2000 was certainly a year of change in taxation in Ontario. Major changes were announced not once, but on three separate occasions—on February 28 with the Federal Budget, on May 2 with the Provincial Budget, and then again with the Federal Economic Statement released on October 18. In all three budgets, there were numerous tax incentives announced and the timetables for previously announced tax reductions were adjusted, to the point where it is appropriate now to step back and assess where we are for 2001 and to look at whether old tried and true tax planning strategies still make sense for the new tax landscape and the new millennium.

One of the announcements the province made in May 2000 was that Ontario taxpayers will, for 2001 and future years, calculate their tax based on Ontario income. In the past, Ontario levied its tax as a percentage of the amount of Federal tax paid. Accordingly, if the Federal government introduces tax changes that affect the amount of Federal tax you pay, then automatically the amount of tax you pay provincially will be affected; the province’s tax collection policy thus becomes dependent on changes made at the Federal government level. For 2001, all of the provinces have now opted out of this method of calculating their tax and instead will assess tax as a percentage of taxable income calculated for their province.

What does this mean? In the short term, the only effect will be that your tax return for 2001 will look slightly different. The Ontario portion of the tax return will be a little more complicated likely with a schedule calculating Ontario taxable income. However, in the future, it is likely that you will see a greater divergence between your level of taxable income for your provincial income versus your Federal income. It is also possible that the province may introduce incentives that will not be matched federally. Your personal and spousal tax credits could become different provincially versus federally. Overall, since the province has a greater ability now to introduce legislation that will affect the amount of tax you pay in Ontario, it is very likely that the provincial budgets will become increasingly important as a tool to meet the government’s goal to stimulate the provincial economy.

Another important change that occurred in 2000 was the dramatic reduction in the inclusion rate for capital gains. The February Federal budget reduced the inclusion rate from 75% to 66 and 2/3%. In May, the province retroactively matched the Federal reduction and further challenged the Federal government to continue reducing the inclusion rate. The province planned to reduce its inclusion rate from 66 and 2/3% to 62% effective January 1, 2001, regardless of whether the Federal government matched its plan or not. The province had committed to reducing the inclusion rate to 50% by 2004 and Finance Minister Ernie Eves actively encouraged the Federal government to match his reduction plan. The Federal government countered with a further inclusion rate reduction in its October economic statement (or mini-budget) which reduced immediately the inclusion rate to 50%. A couple of months later, the Ontario government announced it too would reduce its inclusion rate to 50%.

What does this mean for tax planning? The reduction in the capital gains inclusion rate has some significant tax planning implications. In 1999, at the highest rate, capital gains in Ontario were taxed at 36.57%, whereas Canadian dividends were taxed at 32.92% (See Table 1). This difference is tax rates has been the case since the late 80s when the capital gains inclusion rate was increased from 50% to 75%. Traditionally, the planning strategy has been to, wherever possible, turn interest income or capital gain income into dividend income. In 2001, the highest rate for capital gain income is 23.21% and for dividend income it is 31.34%. There is now a significant advantage to generate capital gain income rather than interest or dividend income. This will be important when structuring the sale of businesses and looking at inter-generational transfers of businesses. It will also be important to keep this new taxing structure in mind when looking at your investment options. The reduction in the capital gains inclusion rate is a significant windfall for the taxpayer. However, it will now take proper tax planning and investment decision-making to fully utilize this windfall.

Another significant change announced by the Federal and Provincial governments in 2000 concerns the drop in both the personal tax rates and corporate tax rates.

These rate adjustments are very important when reviewing owner/manager remuneration packages. First of all, the highest tax rate for regular employment income has dropped from 47.86% in 2000 to 46.41% in 2001. And this highest rate of tax now does not kick in until an individual’s personal income exceeds $100,000. Previously, the highest level of tax would take effect at approximately $60,000. As a result, where income levels can be manipulated, consideration will now need to be given to whether or not to increase personal incomes to fully utilize these lower tax levels.

The Ontario government is also reducing the amount of tax on active business income eligible for the small business tax credit. Additionally, the Ontario government is increasing the amount of income that is eligible for the small business tax credit. For example, in 1999, the first $200,000 of small business income attracted an Ontario tax of 8.5%. Effective January 1, 2001, the first $240,000 of small business income will attract an Ontario tax of 6.5%. By January 1, 2005, the first $400,000 of small business income will attract an Ontario tax of only 4% under the current schedule of implementation. Federally, however, the government has not increased the full small business tax incentives beyond the $200,000 threshold. However, it has provided some relief for income between $200,000 and $300,000. As a result, for 2001 there will be several different corporate tax rates depending on a company’s level of income. On the first $200,000 of active business income, the corporate rate is 19.62%. From $200,000 to $240,000 the corporate rate becomes 28.62%. From $240,000 to $300,000 the corporate rate jumps to 41.12%. On active business income in excess of $300,000, the corporate rate jumps to 47.12%. (These rates are assuming no manufacturing and processing deduction.)

As a result of these fluctuations in rates and future increases in the small business income limit for Ontario, ongoing tax planning will be needed on an individual client basis, concerning the level of bonus needed each year to maximize the lower corporate tax rates. In the past, the decision-making was fairly easy. “Bonus down” to $200,000 unless you can take advantage of other tax incentives or planning opportunities. Now, we will still need to consider the other tax incentives and planning opportunities, as well as consider “bonusing down” to $240,000 for 2001 or $280,000 for 2002 while recognizing that the tax advantages will not be as great as they are on income taxed up to $200,000. While the solutions are simple mathematical calculations, at the individual level the reality can prove to be much more complex.

Overall, 2000 was a great year for tax changes both at the corporate and individual level. Tax changes often provide opportunities. With proper planning and careful consideration, opportunities can be converted into tax savings and more money for you and your business. If we are fortunate, the government will introduce more tax changes in 2001 which will provide us all with even more tax savings for the years ahead.

Steve Thompson, CA, CFP, TEP is a tax partner and Certified Financial Planner with Wilkinson & Company LLP. He is a graduate of the Canadian Securities Course, and author of the best-selling tax guide, Beat the Taxman: Easy Ways to Save Tax in Your Small Business.