Jamie Golombek: Tax-efficient interest income no longer an oxymoron
Jamie Golombek CA, CPA, CFP, CLU, TEP is Managing Director, Tax & Estate Planning with CIBC Private Wealth Management. He works closely with advisors to help them provide integrated financial planning solutions for their high-net-worth clients. Jamie is frequently quoted in the media as an expert on taxation. When it comes to tax-efficient, non-registered investing, it’s not what you earn but what you keep that matters. That’s because not all investment income is taxed equally. For example, depending on which province you live in, either Canadian dividends or capital gains will be far more tax efficient than interest income. Canadian dividends are tax-favoured due to the federal and provincial dividend tax credits, which can cut the effective personal tax rate on dividends to less than half the rate of interest income. Similarly, capital gains realized on the sale of securities, whether they are held directly, or indirectly through a mutual fund, are also extremely tax efficient as only fifty per cent of capital gains are taxable at your marginal tax rate. Of course, in last place on the spectrum of tax efficiency, no matter where you reside, is interest income, which is simply fully taxable at your marginal tax rate. That’s why investors have struggled for years trying to come up with a tax-efficient way to invest in fixed income securities outside a registered plan. We put this task to the alchemists at Renaissance Investments, who have come up with a way to generate capital gains where the return is based on an underlying diversified, professionally– managed corporate bond portfolio, resulting in a tax advantage for investors.
Through the use of forward sale contracts, also known as ‘swap agreements’, the Renaissance Corporate Bond Capital Yield Fund seeks to generate and pay out a tax-efficient monthly distribution that will be characterized as a capital gain as opposed to ordinary income. As the example below shows, an Ontario investor in the top marginal tax rate of 46.41%, who invested in the Fund and received a 3% pre-tax return, would yield 1.92% after tax and forward contract fees by having the return paid out in the form of capital gains, versus only 1.61% if the same pre-tax return was taxed as interest income – a tax benefit of almost 20%. An illustration of the tax treatment on interest income vs. capital gains. Pre-tax return
3%
4%
5%
3%
4%
5%
Income tax1
1.39%
1.86%
2.32%
Net after-tax return
1.61%
2.14%
2.68%
Net pre-tax capital gains2
2.50%
3.50%
4.50%
Capital gains tax1
0.58%
0.81%
1.04%
Net after-tax return
1.92%
2.69%
3.46%
Interest income scenario Interest income earned
Capital gains scenario
Assumes interest income tax rate of 46.41% and capital gains tax rate of 23.20% (top Ontario tax rate for 2012, not considering the high-income surtax proposed in the 2012 Ontario provincial budget). 2 Net pre-tax capital gains return is after assumed forward sale agreement costs used in the structure. 1
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Jamie Golombek: Tax-efficient interest income no longer an oxymoron
There are risks associated with an investment in the Renaissance Corporate Bond Capital Yield Fund, including risks with respect to the tax treatment of the return generated. For further information regarding these risks, please refer to the Simplified Prospectus. There is a counterparty fee associated with the forward sale agreement. Renaissance Investments is offered by CIBC Asset Management Inc. Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the Renaissance Investments family of funds Simplified Prospectus before investing. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated. ™ Renaissance Investments and “invest well. live better.” are registered trademarks of CIBC Asset Management Inc. 2
44-2290E(201206)
For further information on the structure of the Renaissance Corporate Bond Capital Yield Fund, please refer to the Renaissance Investments family of funds Simplified Prospectus, http://www.renaissanceinvestments.ca/en/downloads/statutory/renaissance/sp_ri_e.pdf