Did you know that the Canada Revenue Agency (CRA) has several tax breaks that are exclusively for the benefit of investors?
It’s true. You may have heard about the dividend tax credit and the capital gains tax rate. These are quite well known, but there are other tax credits available to investors that you may not have heard of. In this article, I will explore three CRA tax breaks that you can take advantage of as an investor — including one that not very many people know about.
Investment tax credit
The investment tax credit is a special tax credit you can get if you invest in scientific research or experimental development. It’s mostly businesses that get this credit, but individuals can, too, if they are working as independent researchers. The investment tax credit is 35% for up to $3 million dollars worth of investments and 15% for amounts over the $3 million threshold. This credit is unique in that a portion of it shaves 35% off your tax bill instead of 15%; the latter is standard for tax credits in Canada.
The dividend tax credit
The dividend tax credit is a special tax credit you get on dividends earned from common stocks. The way it works is it gives you a 15% credit on the total amount of dividends you received, which are “grossed up” by 38%. So, you get a credit on an even larger amount than what you actually received in dividends. Sometimes, this credit can actually result in you paying no taxes on your dividends whatsoever!
The capital gains tax rate
Last but not least, we have the capital gains tax rate. This one is less of a credit and more like a deduction: only half of your capital gain is taxable. So, if you have a $1,000 realized gain and your marginal tax rate is 33%, you pay $165, not $330.
How they come together
The dividend and capital gains tax breaks can result in big savings when combined.
Let’s say that you had invested $100,000 in Fortis (TSX:FTS) stock at the beginning of year, and it rose to $110,000 by the end of the same year. Let’s also assume that your marginal tax rate is 33%. You’d have a $10,000 capital gain from your investment, of which $5,000 would be taxable, leaving you with $1,650 in taxes. Without the capital gains tax rate, you’d be on the hook for $3,300. Ouch.
It’s a similar story with dividends. Fortis stock has a 4.22% yield, which means that a $100,000 position in it generates $4,220 in annual dividend income, assuming the payout doesn’t change. Historically, the payout has risen — it has risen 50 years in a row, in fact! But that’s beside the point. What matters is that the $4,220 in dividend income would be multiplied by 1.38, giving us $5,824 in “grossed-up dividends.” That, in turn, results in a $873.6 tax credit, which reduces the $1,392 in taxes you’d normally have to pay on your dividends to just $519. Talk about savings!
