A tax break for RRSPs/RRIFs?

Some strong opponents of the income trust tax have resigned themselves to the fact that the measure will go through and are now focusing on ways to remove some of the inequities contained in the plan.

That was the main thrust of the presentation made to the Finance Committee this month by Dirk Lever of RBC Capital Markets. Instead of railing against the proposal, he focused instead on the unfairness of double-taxing payments to pension plans, RRSPs, RRIFs, etc.

In his prepared statement, Lever pointed out that double taxation was eliminated on dividends paid to non-registered accounts when the government increased the dividend tax credit last year. But there is no relief for dividends paid to registered plans, nor will there be for trust distributions once the tax comes into effect. (The dividend tax credit will apply to trust distributions after 2010.)

Noting that dividends are paid after corporate taxes are assessed, he pointed out that “Canadian pension funds are not given a dividend tax credit, and the Canadian pension fund then makes a distribution to a Canadian pension beneficiary with after-tax dollars, but that Canadian pension recipient is subject to full taxes on their pension benefit – no tax credit is passed along to the Canadian pension beneficiary, and taxes are paid a second time on that same income.”

He went on: “The problem of double taxation does not exist with interest income, so why should it with dividend income? Consider that interest paid by a Canadian corporation or government is paid without first being subjected to tax. A Canadian pension fund can then distribute the pre-tax interest income to Canadian pension beneficiaries who will then pay tax on the interest income for the first time. From this simple example you can understand that from the perspective of a Canadian pension beneficiary, a dollar is worth less if it starts off as Canadian corporate income than if it starts of as interest from a Canadian corporation or government. In this instance, a dollar is not a dollar, because of double taxation. The proposed trust taxation will do the same thing to trust distributions – the distributions will be subject to double taxation in the hands of Canadian pension beneficiaries.”

To illustrate the point, RBC submitted a table showing the total tax impact of the Flaherty plan on investors. Using a top marginal tax rate of 46 per cent, a taxpayer receiving a dividend (or a trust distribution after 2010) in a non-registered account would have an after-tax return of 54 per cent. In a registered plan, the effective tax rate would be 64 per cent (corporate and individual) and the after-tax return just 36 per cent.

Lever’s solution would be to apply the dividend tax credit to pension and registered plans as well. “For some low tax rate Canadians, this may mean an actual tax refund; for Canadian registered pension plans this will mean a full tax refund. In this way, Canadians can be assured that they will not be taxed twice on income received from their retirement funds and plans. We believe our amendment will help make the current proposal fair.”

Sounds good in principle and Britain has already done something similar. But we have yet to see any estimate of what such a plan might cost and there has been zero indication from the government that they are even prepared to consider the idea. However, others have been proposing similar plans so maybe the idea will gain some traction going forward.