By lowering corporate tax rates and offering tax incentives to investors, provincial governments are actively using their taxation regimes to compete aggressively for new and expanded economic activity.

That should both concern and encourage harried advisors and their clients. Each provincial tax incentive offers more opportunity for the sale of specialized investment vehicles. This means more opportunities for marketers who can package securities to offer the maximum after-tax return. But each incentive also brings with it a different set of rules, putting more responsibility on the shoulders of the advisor.

Although incentives may not be extensive in all provinces, competition among provinces almost guarantees that more will appear.

The most obvious arena is the rate of tax on corporate profits set by each province. This year’s budgets continued the trend toward lower rates. Prince Edward Island, Nova Scotia, New Brunswick, Quebec and Manitoba lowered their corporate rates and raised the threshold at which the special low rates for small businesses phase out. This trend is independent of the proposed changes in federal corporate tax rates.

This is beneficial for clients interested in inter-provincial investing and tax planning. It is possible to own stocks from a jurisdiction with very low corporate rates and live in a province with a relatively high rate for the dividend tax credit, thus maximizing the after-tax return from investments in dividend-paying companies.

Meanwhile, each province has an elaborate system of tax incentives to encourage activities such as film production and investment in manufacturing and processing equipment. Many incentives are targeted only at the primary investors, however, and cannot flow through to ordinary investors.

But there are a number of incentives that are generally available to individuals in all provinces and are delivered by way of tax credits. It is not possible to provide a comprehensive list of the specific tax incentives available in each province or territory for things such as investment in venture-capital funds or flow-through mining shares. Each province has a unique combination of incentives, with various qualifications.

There is no single source of information, but, as always, the Internet can provide more than sufficient information. Some provincial Web sites — for example, the site for Saskatchewan’s Finance Department (www.gov.sk.ca/finance) — are well organized and describe each tax incentive. But in other cases, a lot of digging will be necessary.

Because all provinces except Quebec have collection agreements with Canada Revenue Agency, the CRA’s Web site (www.cra-arc.gc.ca) is a good place to start.

Look at the provincial forms for 2004 to get an idea of what has been available. Under the forms section, T1 General, you will find a section called 2004 T1 General Returns, Forms and Schedules (www.cra-arc.gc.ca/menu/LBA-e.html) with a set of forms for each province except Quebec.

The forms with the letter “N” following the provincial number provide a summary of all tax credits available. The provincial Finance or Revenue Web sites can provide further details once the basic program name has been determined.

Information about changes for 2005 and later years has to come from the individual budget statements. It is not necessary to know all the rules, but advisors should know those that apply in their provinces.

Quebec is a unique situation, simply because it has its own legislation and administration.
Residents in this province have a much wider choice of tax incentives. Here again, the Revenue Québec Web site (www.revenu.gouv.qc.ca) provides ample information about the criteria for its special programs, most of which are targeted toward specific activities.

The Quebec system is far more complex, and professional tax advice is useful
to determine whether a contemplated investment qualifies and whether the arrangements fall within the rules.

Investors and their financial advisors have traditionally looked at top marginal income tax rates, on ordinary income, dividends and capital gains, in order to choose the best vehicles to suit the clients’ particular circumstances.

The accompanying table (page B6) summarizes the highest marginal rates paid in each province and territory in 2005. At this point, it is unlikely that there will be major changes in the coming year. The table also shows the rate of tax on capital gains, which is one half the rates applicable to ordinary income (including interest income).

Because there are federal and provincial tax credits to offset at least part of the taxes paid by corporations on the income distributed by way of dividends, this form of income enjoys a lower rate of tax in the hands of individuals. The table shows the net personal income tax on dividends in each province.

@page_break@Not every client will be at the top marginal rate for annual incomes in excess of $100,000. In these cases, and for certain levels of income in the top rate bracket, the net effect of additional income may not simply be the dividend or payout less the appropriate income tax rate.

In Ontario, for example, the health premium is payable according to a set scale that rises as income rises. When taxable income reaches $48,000, $72,000 or $200,000, there is a narrow band of $600 in which a 25% marginal rate is applied in addition to regular income tax rates.

Federal and provincial programs of assistance to low-income families and seniors are also geared to taxable income. And your clients may be supporting relatives who are in these groups.

A dividend that is generously attributed to Grandma’s account may result in a little additional cash and no income tax, but, unfortunately, it may also reduce her benefits under the federal guaranteed income supplement, subsidized housing and even Meals on Wheels.

Grandma’s GST refundable credit will also drop by 5% of the additional income, and any provincial sales or property tax credits will drop by a similar amount.

So advisors and their clients should be aware of the tax measures that affect low-income people and seniors, and understand how tax measures may affect future financial well-being. IE