Net Worth Update Feb 2012 (+1.91%) – Market Gains Edition

Since the mortgage is paid off should you still call the Smith Manoeuvre Investment Account as is or call it a plain old leverage account? I’m in a similar postion as you with leveraging but do you have any thoughts on going with a margin account vs. heloc? Assuming the borrowing rates are the same i.e. 3%. I ask because there’s still a lien on the paid off home and would rather use the leveraged securities as the “collateral” instead of the home.

Think it’s time to update the value of your house? Given the market I wouldn’t doubt your house is worth $450,000.

Yes – I am a Newfie as well so I am all too aware of the escalating prices.

However, maybe for dramatic effect you can get your house appraised in December 2014 to boost you over the $1 million mark if you haven’t already made it.

@FrugalTrader – Dividends can be paid at any point in time during the year, provided that the appropriate corporate law matters are met (generally a dividend resolution signed by the directors, and meeting the solvency requirement under corporate law, so that creditors are not disadvantaged). If paying an eligible dividend, you must provide written notification to the recipient of the dividend at the time of payment that the dividend is an eligible dividend. This can be done through a notation on the cheque stub, or if all of the shareholders are also directors, in the dividend resolution. It is important to note that this written notification is not required in the case of a “regular” dividend.

Any taxable dividends paid by the company to a shareholder must be reported on a T5, and filed with the CRA by the end of February.

It’s also worth noting that with a private company, you can only pay eligible dividends if you have GRIP (General Rate Income Pool) available at the end of the year. Any eligible dividends received get added to GRIP dollar for dollar. Therefore, assuming you have received a $100 dividend from a public company in your holding company, you could pay $100 as an eligible dividend as you would have sufficient GRIP. If you pay eligible dividends in excess of your GRIP at year end, there is a penalty tax which can be assessed.

@FrugalTrader – I think that the overall before / after tax aspect is more important for consistency. For example – investment gains inherently have a future tax liability associated with them. Same with RRSP and holding company investment balances. The question is, fundamentally, whether a future tax component should be recognized in personal statements of net worth?

Under accounting standards, corporations reflect future tax liabilities in their financial statements – although those will not always capture the full extent of them, depending on the underlying accounting policies. In a personal net worth context – most people would quote a “gross” number and ignore the future tax liabilities, so I would suggest that using “gross” numbers would be appropriate for comparability. If someone had purchased stock for $1 and it was now worth $1,000 – they would likely say the stock was worth $1,000 – not “$1,000 less a future tax liability.” Food for thought… but I’d suggest keeping it off for broader comparability. That being said, the most important aspect is personal consistency… so your call!

For dividends – I can confirm that eligible dividends essentially flow through (although it depends on the province). A $100 eligible dividend will attract a $33 refundable Part IV tax, which is refunded at the rate of $1 for every $3 of taxable dividends paid. Therefore, the $100 from a public company (eligible dividend), will attract $33 of tax in the company. When a $100 dividend is paid (as an eligible dividend), the company will receive the $33 back, and the shareholder will pay tax. In Ontario, at the top marginal rate, that is 29.54%. To follow it through – the shareholder would pay apx $30 in tax (in this example). Therefore, if the dividend was not paid out of the company in the same year, there is a prepayment of $3 of tax.

The exact nature of the “flow through” and deferral or prepayment of tax will depend on the province and the shareholder’s marginal tax rate.

@Saveddijon – Investment income (not dividends) in a holding company is taxed at apx 50% – depending on the province. However, of that 50%, just over half (26.67% of the total) is a refundable tax. That tax is refundable when a taxable dividend is paid at the rate of $1 for every $3 of taxable dividends which are paid.

Therefore, the refundable tax is really just a prepaid tax – one that assumes that the recipient of the dividend is in the top marginal bracket. If the income was earned in the company and paid out to an individual right away (one who is in a lower bracket) – the effective tax rate is reduced on the investment income.

The biggest advantage with a holding company is that you can invest after corporate tax funds, as opposed to after personal tax fund. Consider someone with a tax rate of 40% who wants to invest $100. They would need to earn $166 to have $100 left over to invest. In contrast, if that income was earned through a company (which qualified for the small business deduction) – only apx 15% corporate tax would need to be paid. Therefore, to invest that same $100 – the business would only need to earn $117. The additional tax (i.e. the personal tax layer) is deferred until the money is withdrawn from the company via a dividend.

The rates will vary from province to province, but serve to illustrate the concept.