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FP Answers: What are the next steps for saving and investing after paying off student debt?

by Davies Otwell March 24, 2023

To start, clarify your goals so you can determine what to do with your money, financial planner suggests

Savings are important for short-term goals, but for longer-term goals and future use, you want to make your money work for you. Photo by Getty Images/iStockphoto

By Julie Cazzin with Janet Gray

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Q: I’m a 29-year-old graphic artist earning $6,000 a month after tax. This year, I paid off my $30,000 student loan debt. I have $20,000 in my tax-free savings account (TFSA), but I’m not sure what to do with it. I’m doing some long-term planning, and 10 years from now I would like to work only two days a week so I can pursue my hobbies. I recently started reading about investing, but don’t know where to start. Can you give me some good savings and investing advice? — Merlita

FP Answers: Merlita, having no or little debt and some savings certainly gives you more options. Let’s start by clarifying the difference between saving and investing.

Saving is protecting your money and keeping it secure so it doesn’t decrease in value. This is usually best for short-term use and/or emergency funds, and done with products such as high-interest savings accounts or guaranteed investment certificates (GICs). For longer-term goals and future use, you want to make your money work for you. You do this by investing it.

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Start by clarifying your goals, which are the jobs you need your money to do. This is easier if you look at your goals by time chunks: short term (less than 12 months), medium term (one to five years) and long term (six years or more). Try to attach a cost estimate and date to each goal. It will make it easier to plan for.

Some examples of goals could be a holiday within the next year that will cost $1,200 (short term), a new car purchase in the next three years costing $35,000 (medium term) and a goal to retire at age 55 with an annual retirement income of $60,000 (long term).

With the future cost known, you can calculate how much to save while remembering to factor in the investment growth for longer-term goals. For instance, if you need $1,200 in 12 months, the math is simple: you need to save $100 each month. If you are saving for a retirement in 20 or 30 years, the calculations get trickier as there are many factors to consider, so speaking to a financial planner is helpful.

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You might have many goals with potentially different start dates. Once you know the amount needed and the timeline, you are then able to narrow down the asset class (cash, bonds or stocks/equities) needed to match each goal. Choose an investment that is the right tool for the job.

A long-term goal suits longer-term investments, which usually indicates equity or stock investments. A short-term or more immediate goal suits cash. Medium-term goals are better suited to income assets, such as GICs.

Note, the overriding decider is your own risk tolerance. Some call this their “stomach” factor. What does your stomach tell you about the risk you are considering? How much risk can you tolerate? This is another way of asking how much loss you can afford before your goal’s timeline is up.

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With a short-term goal, you would not be able to quickly recover if your money decreased in value before you needed to use it, but if it was a longer-term goal, you would have time to recover and wait for the value to gradually increase again.

Any financial account you open — whether it be a registered retirement savings plan (RRSP) or TFSA — asks you to analyze your risk tolerance on the initial application, and usually annually after that to allow for changes in goals and timelines.

Merlita, you are looking at a longer-term, 10-year goal. Longer-term investments such as equities — mainly in the form of mutual funds and exchange-traded funds (ETFs) for most small investors — are more suited for those goals so that growth can compound over time and increase the amount you started with.

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It’s also wise to regularly review and revise your goals since factors such as interest rates, the economy, employment income and lifestyle can all influence them.

Try to consistently add to your base amount. Set up automatic contributions that match your pay schedule. These contributions encourage investors to deposit to their account whether the value of their investments is up or down. This is known as dollar-cost averaging. You will get a better average price for your investments because you are buying more frequently and at different price points due to different purchase dates rather than buying them all at one time at one singular price.

Look for the service level you require from your investment company. This is usually indicated by how involved you want to be. Some investors want to manage their investments themselves using a DIY brokerage account. The fees are low and you do all the transactions, research and monitoring yourself.

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Other investors use a digital online adviser (also called a robo-adviser). They allow you to input your information and required data, and choose a product their algorithms suggest. The fees are a little higher, but you can speak to their call centre if needed.

Investors can also work with an investment adviser. There is a fee for this, either a percentage of your portfolio’s value or a fee built into the investment product you purchase. Many of them offer services such as insurance, banking and mortgage products.

The takeaway here is to determine how much advice and involvement you want regarding your investments, then make sure you do your research to find the best fit.

Janet Gray is an advice-only certified financial planner with Money Coaches Canada in Ottawa.

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March 24, 2023 0 comment

Real Estate

REITs and RELPs give investors commercial real estate exposure, but they are distinctly different vehicles

by Bailey Amber March 15, 2023

written by Bailey Amber

Chris Warner: Commercial real estate can be an important additional asset class for the right investors

Commercial and residential buildings in Vancouver. Photo by James MacDonald/Bloomberg

The best-performing asset class in many portfolios last year was commercial real estate. That was certainly the case for Nicola Wealth Management Ltd. and other firms that use these types of investment strategies.

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Upon hearing this, some investors may wonder, “How could that possibly be the case when real estate investment trusts (REITs) seem to have been the worst-performing asset class of 2022?” It appears to be a paradox, but it provides a lesson that investment vehicles can matter as much as the asset classes themselves.

To that end, many Canadians only diversify by utilizing publicly traded stocks and fixed-income instruments, whereas we believe that commercial real estate can be an important additional asset class for the right investors.

In this area, Nicola Wealth primarily invests in real estate through the use of limited partnerships (RELPs), where we directly own, develop, and manage properties. Investors also have the option to buy shares in REITs, either directly or indirectly through exchange-traded funds (ETFs). There are differences between RELPs and REITs, such as liquidity, valuation, and investment philosophy. In 2022, the most significant difference was price.

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The characteristic of REITs to quickly reprice based on sentiment, due to their publicly traded nature, was very evident in 2022. This isn’t uncommon. In times of uncertainty, REIT share prices will often deviate from the actual market prices of the underlying property they hold (the net asset value or NAV). This means they can trade above or below the intrinsic value of the pool of real estate itself.

Let’s draw a point of distinction here between price and NAV. Price is what one pays to buy a REIT or a RELP today. The NAV is the assessed value of the underlying holdings.

As mentioned, the price of a REIT may be heavily influenced by investor sentiment and can decouple from the NAV. By contrast, the price of RELPs is typically almost the same as the NAV; it will usually lag the NAV only by the RELP’s frequency of a full valuation.

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REIT price vs. NAV

For REITs, the NAV is the book price, which is the assumed value of all the real estate assets minus any debts and obligations.

A price/book ratio of one would mean that the trading price of the REIT exactly reflects the current NAV. Less than one suggests the REIT is either undervalued or that investors expect its price to decline. Greater than one suggests the REIT is either overvalued or that it might be expected to grow in price. Theoretically, a REIT should trade at a price that is a slight premium above its NAV considering the benefit of its high liquidity versus physical ownership of real estate.

For example, one of Canada’s largest REITs, Canadian Apartment Rentals REIT, traded at a premium in 2018 and 2019 when markets were more stable. When the pandemic emerged and roiled investors, the REIT’s price dropped too. Then in 2021, as markets boomed, it began trading at a premium again.

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Enter 2022 and its very high inflation, sky-rocketing interest rates, and the rare double-decline in stocks and bonds. Canadian Apartment Rentals REIT had one of its most significant valuation falls in recent memory as investors quickly speculated that the future of commercial real estate would become challenging.

Why buy REITs?

Through this example, it becomes evident that REITs can be considerably influenced by investor sentiment, just like public markets. Some might argue this defeats the point of having commercial real estate in a portfolio. However, long-term investors who utilize REITs might point to the real rate of return as a counterpoint, relative to public stocks.

In all, what does this tell us? First, there is a relatively strong long-term case for investing in commercial real estate, depending on the investor. Second, publicly traded investments can be subject to rapid speculation based on fear and greed (note that I am not using those terms as pejoratives, fear/greed indexes are long-used means of summarizing prevailing investor sentiment using a variety of qualitative data). Third, it reinforces why some choose to own real estate through the RELP structure, believing that the investment price and NAV will be closer to real market rates.

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REIT vs. RELP pricing

A natural question may follow the points above: Perhaps REITs declined too quickly, but won’t all commercial real estate eventually follow? In my opinion, the short answer would be “no.”

The inference of the question is that the RELP’s use of a different valuation structure means it will be slower to “catch up” with REITs. While no one can predict the future, there are plenty of reasons for us to believe this won’t be the case.

For instance, RELPs may use many active strategies to hedge downside risk. They don’t usually buy commercial real estate as a monolithic asset class. They don’t focus solely on collecting rents.

Instead, my experience is that RELPs mainly seek diverse, targeted strategies that will perform well in both existing market environments and in the future.

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One interesting point about REITs is that the pricing mechanism can occasionally shift too far to the negative, potentially positioning REITs attractively for the future. Essentially, if a REIT is well-capitalized and is producing steady cash flow, it can be an opportune time for entry when a REIT’s price is well under its NAV (and one even we have considered on occasion).

That said, our preferred long-term approach remains to recommend the RELP structure for potential return maximization and volatility reduction in a diversified portfolio. Our analysis of the two investment vehicles has historically demonstrated higher downside protection for RELPs over REITs, potentially leading to greater long-term returns.

In all, investing in commercial real estate can be a helpful addition to many investors’ portfolios, so long as it is approached strategically. One should understand how the characteristics of RELPs and REITs align with an investor’s profile (including their risk tolerance) and how these investments fit into the overall investment plan.

Chris Warner, FCSI, CIM, CFP, PFP, is a wealth adviser at Nicola Wealth Management Ltd.

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FP Answers: Should I hold onto my large portfolio of preferred shares or diversify?

by Davies Otwell December 17, 2022

written by Davies Otwell

Preferred shares are complicated investments only suitable for knowledgeable investors

Most people invest in preferred shares for the tax-efficient dividend income. Photo by Getty Images/iStockphoto

In an increasingly complex world, the Financial Post should be the first place you look for answers. Our FP Answers initiative puts readers in the driver’s seat: you submit questions and our reporters find answers not just for you, but for all our readers. Today, we answer a question from Elmar about preferred shares.

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By Julie Cazzin with Allan Norman

Q: I am heavily invested in preferred shares. Is it right to stay there in today’s market? Or should I seek out different investments? — Elmar

FP Answers: Elmar, if you are an experienced preferred-share investor, then you know you’ve given me a difficult question to answer with the limited information you’ve provided. What type of preferred shares are you holding: retractable, rate reset, perpetual, fixed floating or floating rate?

Probably the best way for me to answer your question is to explain why I think people invest in preferred shares, give a brief description, provide an example of what I think you’re seeing on your investment statement, and then discuss your options based on the example.

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I suspect most people invest in preferred shares for the tax-efficient dividend income. It’s generally higher than guaranteed investment certificate (GIC) or bond income, and there is a perceived safety in owning preferred over common shares.

Preferred shares are equity investments that pay a fixed dividend, but they don’t share in the growth of the issuing company like common shares do. If the issuing company goes bankrupt, bond holders will be paid out first, followed by preferred shareholders and then common shareholders. In reality, I doubt preferred shareholders will receive anything if the issuing company goes bankrupt.

The share value of a preferred share will rise and fall with changes in interest rates, similar to a bond. Share value goes down when interest rates go up, and share value goes up when interest rates go down. Unlike bonds, there is no maturity date, so the dividend payments in most cases never end, unless the issuing company calls to redeem the preferred share or goes bankrupt.

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The issuing company will most likely redeem a preferred share when it is in their best interest to do so. This may happen when a new preferred share can be issued at a lower dividend rate than the current rate.

Rate-reset preferred shares are the most common type of preferred shares in Canada and the accompanying table shows a real example of what a rate-reset preferred share may look like on an investment statement right now:

The table tells you a few things: the dividend rate at issue, or at last reset, was 4.57 per cent; if sold today, the capital loss would be $8,727 (book value minus market value); and the current yield is 6.08 per cent, or annual dividend payments of $1,395 ($22,950 times 6.08 per cent).

Elmar, based on what’s presented in the table, should you hold or sell this preferred share? It depends on how you like to invest, your goals, when you need the money and other factors, coupled with some future unknowns such as changing interest rates.

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If you hold, you will continue to collect the dividends even though the share value is down. It isn’t too different from having a rental property drop in value while the rental income continues. In the case of a rental property, you likely wouldn’t sell the rental if your primary goal is income, or you would wait until the property went back up in value before selling.

If interest rates continue to go up, the value of the preferred share is likely to go down. However, there will be a rate reset in 2024 based on the five-year Bank of Canada bond yield plus a spread. Under that scenario, you will receive a higher dividend payment in 2024.

Ideally, once the new dividend rate has been set in 2024, interest rates will start to fall, causing your share price to rise. The catch is, if interest rates fall too much, the issuing company may redeem the shares at the issue price. This is why preferred shares have limited upside potential, but that may not be a concern to income-oriented investors.

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Selling preferred shares in a non-registered, or cash, account, means creating a capital loss of $8,727 in our example, which can be indefinitely carried forward to offset future capital gains or those earned in the past three years, or it can be applied against income from a registered retirement savings plan or registered retirement income fund in the year of death.

If your intention is to sell and reinvest, then I’m going to assume your goal is to make back your capital loss faster than if you continue to hold the preferred share.

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Is there an alternative investment opportunity right now that you’d be comfortable with? For example, do you see down markets as a buying opportunity with the potential for markets to recover faster than the preferred shares?

Alternatively, if dividend income is important to you, are there any dividend-paying stocks with a similar dividend rate to your preferred share?

There is no clear winning choice here, Elmar, and, as I hope you can see, it depends. Preferred shares are complicated investments and I think they are only suitable for knowledgeable investors.

Allan Norman, M.Sc., CFP, CIM, RWM, provides fee-only certified financial planning services through Atlantis Financial Inc., and is registered as an investment adviser with Aligned Capital Partners Inc. He can be reached at www.atlantisfinancial.ca or alnorman@atlantisfinancial.ca. This commentary is provided as a general source of information and is not intended to be personalized investment advice.

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December 17, 2022 0 comment

Personal Finance

FP Answers: How do I use stock losses to lower my income taxes?

by Davies Otwell November 18, 2022

written by Davies Otwell

Be sure to consider whether to carry back or carry forward a loss to get the best bang for your buck

Capital gains are taxable and capital losses are deductible if securities are held outside a registered account. Photo by POSTMEDIA FILES

By Julie Cazzin with Andrew Dobson

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Q: I lost half the price of my shares (a loss of roughly $5,000) and the brokerage sent me a report of the loss. Can this loss be used to lower taxes and how does that work? Can I lower taxes from previous years? Future years? How do I know what works best? — Charlie, Halifax

FP Answers: Capital losses occur when you sell or are considered to have sold capital property for less than its adjusted cost base. In layperson’s terms, capital property generally includes securities such as stocks, bonds, mutual funds and exchange-traded funds, some of which may be sold at a loss rather than a profit, or capital gain.

Capital gains are taxable and capital losses are deductible if securities are held outside a registered account. You cannot claim capital losses in accounts such as registered retirement savings plans (RRSPs), tax-free savings accounts (TFSAs) or registered education savings plans (RESPs), nor are the capital gains taxable. In your case, a $5,000 loss looks to have been triggered by the sale of securities in your non-registered investment account.

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Only 50 per cent of a capital gain is taxable and only 50 per cent of a capital loss is deductible on your tax return. The 50 per cent used to make these calculations is referred to as the inclusion rate.

Your $5,000 realized capital loss can be used to offset realized capital gains in the current year. If you don’t have any capital gains this year, or if you have more combined losses than gains this year, you have options.

You can claim the loss on any of your three previous tax years or in any future years. If you apply the loss to a previous year, it’s called a carryback and can be processed without filing a brand-new tax return.

To carry back losses, you file a T1A Request for Loss Carryback form as part of your tax filing for the year you realize the loss. Keep in mind the carryback does not affect your net income, nor does it affect benefits that are income tested for those years.

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To carry forward a loss, the Canada Revenue Agency (CRA) will record the carry forward and make a note on your annual notice of assessment until the loss is used. You can choose to use the loss against a future capital gain by claiming the loss on line 25300 of your tax return (net capital losses of other years).

Just because a loss carryback can be used to generate a tax refund in previous years doesn’t mean you should request the carryback simply because you can. Reviewing your overall tax situation over a period of time can be more effective in determining the value of the carryback.

For instance, if you anticipate being in a higher tax bracket in future years than one of the previous three years when you had taxable capital gains, it may make more sense to hold onto the net capital losses for future use.

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A good example may be if you own a rental property or cottage that you intend to sell in the near future, which will give you a huge spike in your income. You could carry forward the net capital loss and may save more tax than you could get refunded on a carryback to a previous year.

If you do not have any capital gains with which to offset your net capital losses during your lifetime, you may still be able to use these losses on your terminal tax year, which is your final tax return in the year you die.

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There is a special tax rule that allows individuals who have net capital losses to apply these against capital gains the same way you could in any other year, and be claimed against your other income in that year.

Keep in mind that to accomplish this, all net capital losses must be applied against capital gains in the year of death first, and if this still results in a net capital loss, these losses can be applied against capital gains realized in the three previous years. Only after applying the losses this way first can they then be used to offset other types of income on your final tax return.

There are a few strategies where capital losses can be tactically used to minimize tax during a specific tax year. The concept of tax-loss selling involves selling investments in the current year to offset the current year’s capital gains. If you have capital gains on other investments for the year, you could trigger losses on other securities to try to reduce your income and your tax for the year.

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In summary, there may be a way to recoup some of your loss, at least from a tax perspective, by saving tax or getting a refund on capital gains on a successful investment. Just be sure to consider whether to carry back or carry forward a loss to get the best bang for your buck.

Andrew Dobson is a fee-only, advice-only certified financial planner and chartered investment manager at Objective Financial Partners Inc. in London, Ont. He does not sell any financial products whatsoever. He can be reached at adobson@objectivecfp.com.

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November 18, 2022 0 comment

Personal Finance Real Estate

FP Answers: Should I put my seven rental properties into a corporation? Or is there a better option to save on taxes?

by Davies Otwell November 11, 2022

written by Davies Otwell

There may be no annual tax savings by adding rentals to a corporation, especially if you are a highly paid employee

A for rent sign outside a home in Toronto. Photo by Cole Burston/The Canadian Press files

By Julie Cazzin with Allan Norman

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Q: I have seven rental properties in my name. Should I put them into a corporate structure? What is the benefit (if any) of doing this? Are there any better options? Right now, I’m reporting the income and losses on these on my personal tax return. — Mason, London, Ont.

FP Answers: Mason, you have a lot to consider when deciding if a numbered company makes sense, including creditor protection, estate planning, the capital cost allowance (CCA), cash damming, possible tax advantages and the cost of setting up the corporation ($2,000 or more).

There will also be accounting and legal fees to properly transfer the properties into a corporation, annual corporate tax returns to pay for, a separate bank account to manage, a minute book of important documents to keep, mortgage transfers and land-transfer taxes to consider, as well as other requirements.

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Creditor protection is one benefit of transferring your rentals into a numbered company. With seven rental properties — representing, I suspect, a significant portion of your net worth — some additional protection may be a good thing if you’re ever sued personally.

There may be no annual tax savings by adding rentals to a corporation, especially if you are a highly paid employee. Corporations pay a low corporate tax rate on active business income, not passive income, which is most likely what your rental income will be considered.

I recommend you visit your accountant and confirm the tax-rate differential between your personal income and your proposed rental corporation and help identify any tax savings.

Corporate business owners with active business income, on the other hand, are more likely to have rentals in a holding company. They can accumulate the down payment for a new property much faster than you could personally.

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For instance, earning a dollar of active income leaves you with about 85 cents to invest after tax, whereas you may be only left with 50 cents after tax if you’re earning that income personally.

As your operating company earns excess money, you can send it as dividends to your holding company for investment purposes, such as investments in rental properties. Estate planning is another reason to consider moving your rentals into a corporation. That is, to defer capital gains tax and avoid probate.

If you’re leaving your rentals to your children, there will be capital gains tax to pay on your death —whether the properties are sold or not. The capital gains tax on the rentals can be deferred if held in a corporation when you pass, but you may face a larger capital gain on the transfer of your corporate shares to your children if the rentals appreciated in value. An added benefit to consider is avoiding probate fees by placing a second will on your corporation.

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I’m curious, Mason, what are you doing about the capital cost allowance? If you haven’t yet, explore this with your accountant, even if it’s just for your own knowledge.

Generally, you can deduct four per cent of your building’s value from your taxable income each year, with the first year being an exception. That’s a nice tax saving, but there is a catch, and it’s called “recapture.” Selling a property that hasn’t depreciated, in which you’ve claimed the CCA, means paying back the amount claimed.

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For example, if you deducted $100,000 over 20 years and the property hasn’t depreciated by four per cent each year, you’ll have to pay back the $100,000, but inflation is your friend in this case. Would you rather pay a dollar today or that same dollar 20 years from now? It is often better to defer because the value of a dollar decreases over time.

The CCA can be claimed whether your rentals are owned personally or corporately. If you are going to claim the CCA, which is annually optional, make sure you have a good understanding of how it works over the life of the rental by working with an accountant who can run the numbers for your particular case.

Also consider cash damming, especially now that interest rates are rising. In general, cash damming is a strategy to convert personal debt (the interest on which is not tax deductible) to business debt (interest is deductible). This is only for people with large non-tax-deductible debts such as a mortgage or large car loan.

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The basic approach is to use your monthly rental income to pay down the mortgage on your non-tax-deductible debt (that is, your personal mortgage). Then you borrow funds to pay down the mortgage on your rental property. In essence, you are converting a non-tax-deductible debt into a tax-deductible debt.

Mason, I’ve given you some guidelines, but there is no easy answer. Talk to a lawyer, accountant or financial planner experienced in this area to work out the details.

Allan Norman provides fee-only certified financial planning services through Atlantis Financial Inc. He is also registered as an investment adviser with Aligned Capital Partners Inc. He can be reached at www.atlantisfinancial.ca or alnorman@atlantisfinancial.ca

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November 11, 2022 0 comment

Personal Finance

What are share buybacks and why is Ottawa taxing them?

by Davies Otwell November 8, 2022

written by Davies Otwell

‘It’s not a dirty thing. It’s not something we should say, ‘ew, that’s gross’

Deputy Prime Minister and Minister of Finance Chrystia Freeland attends a news conference about the fall economic statement in Ottawa. Photo by Blair Gable/Reuters

There’s been plenty of noise since the federal government announced plans last week to tax companies that use their profits to buy shares back from investors. Below is a base-level explainer of share buybacks, their purpose and why Ottawa is setting its targets on one of the ways corporations reward their investors.

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What are share buybacks?

On a basic level, share buybacks, or stock buybacks, are one of five ways a company can spend its profits, said Barry Schwartz, chief investment officer and co-owner of Baskin Wealth Management. When a company has cash after subtracting its costs to run the business, executives can allocate the leftover in the following ways by:

paying dividends to its shareholders at the end of a quarter or fiscal year;
paying off incurred debt;
investing back in the business in the form of hiring or increasing wages, growing its customer base by building more physical stores or pouring more resources into research and product development — to list a few examples;
buying or merging with other businesses that the company sees as beneficial to growing its core business;
and/or through share buybacks, wherein the company will use its profits to buy back stocks of its business from investors willing to sell those stocks.

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“It’s not a dirty thing. It’s not something we should say, ‘ew, that’s gross,’” Schwartz said of share buybacks. “It’s part of your five tools of capital allocation as a CEO or a CFO.”

Why do companies buy shares back from investors?

There are several reasons companies might choose to execute share buybacks and it’s “a function of a properly formed stock market,” Schwartz said. When a company buys back its shares, it reduces the number of outstanding shares in the stock market and theoretically its share price should rise. If the investor did not sell her shares back to the company, she still has the same number of shares but her stake in the company has increased without her having to spend money to buy more stocks.

If a company’s board has created an incentive or bonus structure for executives based on the performance of a stock price, a CEO could decide he or she will use the company’s profits to repurchase its investors’ stocks. Schwartz said this isn’t inherently a negative motivation for executives, especially if the board decided increasing the value of the share price is one of its focus areas in growing the business.

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“Now, share buybacks, like any other capital allocation decisions, can be problematic if you’re using them to artificially prop up the stock without regard for the value of your company,” Schwartz said.

Companies can also decide to repurchase shares if executives believe the current stock market price is trading below what they think it’s worth. Leaders can run calculations, determine what the value of the product they sell might be in the future, take into account current production levels, among a whole host of other considerations, and deem that the price ought to be higher. Natural supply and demand math kicks in there when companies repurchase shares, Schwartz said, and the stock price goes up, further making the share attractive to investors who might pour more money into the company’s shares.

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Shareholders also sometimes prefer buybacks over receiving quarterly or annual dividends because Canada’s tax structure has lighter levies on capital gains earned from share repurchases compared to taxes on income earned from dividends.

“Over time, if a company continues to reduce the number of shares outstanding, and you don’t sell, your ownership will increase tremendously,” he said.

Why is the federal government taxing buybacks?

Deputy Prime Minister and Finance Minister Chrystia Freeland introduced the plan to tax companies two per cent on their share buybacks last week in the Fall Economic Statement and said details of the tax will be in the upcoming April budget. The Liberal government framed the tax as a way to incentivize companies to deploy their profits in their workers and grow their business, rather than paying out those profits to investors.

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The tax should come into effect on Jan. 1, 2024 and would bring in $2.1 billion over five years, the federal government said. It’s similar to a one-per-cent buyback tax the United States introduced this year as part of its inflation fighting bill.

Some say the planned tax directly targets Canada’s energy sector, which has enjoyed windfall profits in recent quarters due to high oil and gas prices from inflation and the invasion of Ukraine by Russia, one of the world’s biggest energy producers, limiting supply in the global market.

For other sectors, the tax might not present a huge hindrance when a company makes capital allocation decisions, Schwartz said. “Buybacks are not a huge part of capital allocation in Canada. They’re much more prevalent in the U.S.”

Citing banks and railway companies as examples, Schwartz said, “A lot of our Canadian large-cap companies are very mature businesses and very much dividend-focused. … These companies don’t buy back stock.”

• Email: bbharti@postmedia.com | Twitter: biancabharti

November 8, 2022 0 comment

Personal Finance

Ottawa reveals plan for new tax on stock buybacks

by Davies Otwell November 4, 2022

written by Davies Otwell

The tax plan is expected to increase federal revenues by $2.1 billion over five years

Publishing date:

Nov 03, 2022 • 14 minutes ago • 4 minute read • Join the conversation

Deputy Prime Minister and Minister of Finance Chrystia Freeland attends a news conference about the fall economic statement in Ottawa. Photo by Blair Gable/Reuters

The federal government plans to impose a new tax on public companies who pursue share buybacks, a popular way to reward investors and reduce volatility, but one criticized by some politicians for diverting funds away from pressing goals like the energy transition and domestic job creation.

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The tax plan, unveiled by Finance Minister Chrystia Freeland in her fall economic update Thursday, is to be fleshed out in the 2023 budget and come into force Jan 1, 2024. It is expected to increase federal revenues by $2.1 billion over five years.

Freeland said the tax will be “similar” to the one per cent buyback tax in the Inflation Reduction Act signed into law by U.S. President Joe Biden in August.

“We’re taxing share buybacks to make sure that large corporations pay their fair share, and to encourage them to reinvest their profits in workers and in Canada,” Freeland said in prepared remarks for the economic update.

“While buying back shares is one legitimate way that corporations can return value to their shareholders, it can also divert corporate resources away.”

Energy companies weren’t singled out, but recent share buybacks amid record profits from rising oil prices and inflation have drawn criticism from government.

Environment Minister Steven Guilbeault, in particular, criticized oil companies earlier this month for returning money to shareholders while making limited investments in energy transition.

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Oil and gas companies are making record profits.

It’s time for them to make record investments in clean energy and reducing pollution. pic.twitter.com/km14XbZ3ST

— Steven Guilbeault (@s_guilbeault) October 27, 2022

At a news conference Thursday, Freeland said she believes the share buyback tax is better than a “windfall” tax on energy companies, such as the ones imposed by the United Kingdom and European Union. Canada itself has imposed specific levies on financial institutions including banks and insurers, noting that government initiatives helped them remain were profitable throughout the COVID-19 pandemic.

Freeland said she believes the share buyback tax announced Thursday is a “very appropriate step” because it sets up an incentive for all public companies.

“What that tax does is it create an incentive to do precisely what we want to see big Canadian companies doing… taking their profits and investing them in the productive capacity of Canada,” she said.

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“It’s a smart tax. It will raise some money for Canada, which is a good thing. But perhaps even more importantly it creates the right set of incentives for companies to do the right thing.”

Word of the planned share buyback tax leaked out before the economic update, and received a chilly reception from some business leaders and finance experts.

Speaking before the tax on corporate share buybacks was confirmed, Alex Gray, senior director of fiscal and financial services policy at the Canadian Chamber of Commerce, said the tax would limit “efficient” allocation of capital. He added that, in the Chamber’s view, it would hinder Canadian businesses’ ongoing recovery from the economic consequences of the COVID-19 pandemic and as recession concerns mount.

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“As stock buybacks help improve stock liquidity while limiting stock volatility, such a proposal would ultimately increase economic uncertainly at an already precarious time,” he said.

“When higher volatility is expected, companies can increase their buyback intensity to stabilize stock prices, thereby enabling smoother trading and lowering transaction costs.”

Yrjo Koskinen, a professor of Finance at the University of Calgary’s Haskayne School of Business, said share buybacks are being “vilified” in public discussion even though it makes more sense to return funds to shareholders via buybacks and dividends than to invest in unprofitable projects.

“This applies to all companies, including energy,” he said.

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Moreover, Koskinen said that if Canada matches the one per cent buyback tax in the United States, it would be unlikely to change the calculus for energy companies that are unlikely to profit from transition investments in the short term.

“If investing in energy transition was unprofitable before the tax, it would also remain so after the tax,” he said. “So the tax on buybacks would be mostly a symbolic act with limited consequences.”

Koskinen said he thinks there should be accelerated investments in energy transition to address the risks of business as usual, but he said there are probably better ways than a new tax.

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“In order to foster long-term investments, it would be of utmost importance to create a stable regulatory and tax environment, so that companies dare to take the plunge,” he said. “To me the tax on stock buybacks sounds more like a gimmick rather than a serious policy.”

In the fall economic update, Freeland reiterated her government’s earlier pledge to introduce a new minimum tax regime for the wealthiest Canadians, and to implement a global minimum tax regime to ensure that large multinational corporations cannot avoid paying taxes, regardless of where they do business.

• Email: bshecter@nationalpost.com | Twitter: BatPost

November 4, 2022 0 comment

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