Article written by Nav Pannu, CPA for DMCL in the Quarterly Canadian News, a newsletter published by
Canadian member firms
of
Moore North America
. This article on the declining market is part of our mission to become your partner in success by keeping you informed.
Seeing the glass as half full: Strategies for when the market is down
We probably don’t need to tell you that it’s been a tough year for investors. The lingering effects of the pandemic, rising inflation, supply chain constraints, war and other external factors have led to significant declines in the markets, which could give even the most secure investors a cold sweat.
You might think that the only thing to do in a down market is to hold on tight, but there are some unique tax-planning opportunities that could give you a head start. Let’s look at some of the ways you can take advantage of a market slowdown:
Selling at a loss for tax purposes
Tax-loss selling is a common strategy for reducing capital gains taxes. It involves selling investments, such as stocks and real estate, that have declined in value, in order to generate capital losses. Even though realizing capital losses can be painful, they can be used to offset capital gains generated during the year, thereby reducing taxes payable for the year.
In addition, net capital losses realized in one year can be carried back three tax years (i.e., 2021, 2020 and 2019) to offset capital gains generated in those years and reduce income taxes already paid (which may result in a refund). Moreover, these losses can be carried forward indefinitely and deducted against future capital gains, giving you greater flexibility as to when you want to reduce your taxes.
It is important to note that capital losses may be disallowed on disposal of an investment if they fall within the rules for apparent losses, which are as follows:
- The same or identical property was acquired by you or a spouse during the period beginning 30 days before the disposition and ending 30 days after the disposition;
- At the end of the period, you or your spouse own, or were entitled to acquire, the same or an identical investment.
Note: This includes your RRSP, TFSA, RRIF and assets held by your or your spouse’s business.
(Re)freezing estates for investment companies
An estate freeze is a strategy that involves exchanging the accumulated value of an individual’s shares in a corporation for “frozen” fixed-value preferred shares. This measure attributes the company’s future growth to the “growth” common shares held by family members.
For companies that already have an estate freeze in place, a downturn in the markets may be a good time to review the overall value of your company’s assets. If the value of a company’s assets has fallen considerably, a new freeze can offer many advantages.
In a refreeze, the preferred shares you own with a higher redemption value are exchanged for new preferred shares with a value equal to the company’s current reduced value. If the preferred shares are worth less than their par value or redemption value, the value of the common shares is nominal.
This can offer several advantages, including:
- Allow future growth to accrue to your common shareholders (family members or discretionary family trusts);
- Reduce the value of your estate and the associated death taxes;
- Permit the payment of dividends to common shareholders, as the company’s by-laws would otherwise have prevented any dividend payments when the value of the company is less than the value of the preferred shares;
- Extend the tax life of a family trust by introducing a new family trust to hold the company’s growth shares (old family trust shares can be nominally redeemed).
Determining the fair market value of the company’s shares is an essential part of executing this plan. Your Chartered Professional Accountant (CPA) can help you with this process, and can examine how an estate freeze or refreeze could benefit you.
Revaluation of individual pension plans (IPPs)
As a reminder, an IPP is an employer-sponsored pension plan that can be set up by and for a single individual, in which contributions accumulate and build up on a fully tax-sheltered basis. Contributions to an IPP are tax-deductible for your company during the fiscal year in which the contributions are made (or 120 days after the end of the fiscal year).
Generally, an actuary, the person responsible for determining whether your plan has sufficient assets at retirement, provides a valuation report at the same year-end as your company. This report will assess the IPP’s financial situation in order to determine the IPP’s contributions for subsequent years. However, some business owners choose to revalue their IPP with a selected valuation date when the value of their assets is in deficit.
In the event of a market downturn, this revaluation can result in an additional contribution amount equal to the shortfall described above, and can also result in a new, higher annual IPP contribution amount. Higher contribution amounts will benefit your company if you wish to reduce tax liabilities in a given year, while increasing the assets available to you at retirement.
A market downturn can be a source of concern for any investor, but implementing the right strategies can make all the difference. Talk to your CPA about how you can use this situation to your advantage. He’ll be happy to identify tax-planning opportunities tailored to your unique financial situation.
