Taxation of Investment Funds and Investor Accounts Flashcards

How does the dividend gross-up mechanism work for eligible Canadian dividends?

Answer: The dividend is increased (grossed up) by 38% for inclusion in income, then a federal dividend tax credit is applied against the tax owing

Eligible dividends are grossed up by 38% to approximate the pre-tax corporate income, and the investor then claims a dividend tax credit to offset the additional tax, reducing the effective rate.

An investor uses a Dividend Reinvestment Plan (DRIP) to reinvest mutual fund distributions. How does this affect the ACB?

Answer: The fair market value of reinvested distributions is added to the ACB, increasing it

When distributions are reinvested via a DRIP, the investor receives additional units at fair market value, and that value must be added to the ACB to avoid being taxed twice on the same amount.

What is the primary tax advantage of holding interest-bearing investments inside an RRSP compared to a non-registered account?

Answer: Interest income inside an RRSP grows tax-deferred, with no annual tax on earnings until withdrawal

Inside an RRSP, interest income is sheltered from annual taxation, allowing the full pre-tax return to compound over time; tax is paid only when funds are withdrawn, ideally at a lower marginal rate.

A mutual fund investor has an ACB of $10,000 for 1,000 units and redeems all units for proceeds of $14,000. What is the taxable capital gain?

Answer: $2,000

The capital gain is $4,000 ($14,000 proceeds minus $10,000 ACB), and since the inclusion rate is 50%, only $2,000 is included in taxable income.

How does the TFSA contribution room work if an investor withdraws funds from their TFSA during the year?

Answer: Withdrawn amounts are added back to contribution room at the beginning of the following calendar year

TFSA withdrawals are added back to contribution room on January 1 of the following year, allowing investors to recontribute the withdrawn amount in later years without penalty.

What is the tax treatment of management fees paid directly by an investor (as opposed to built into a fund's MER) for investment advice?

Answer: They are fully deductible as investment expenses for investments held in non-registered accounts

Investment management fees paid directly by an investor on income-producing investments in non-registered accounts are generally deductible as carrying charges, reducing taxable income.

What is the tax consequence when a deceased investor's RRSP is transferred directly to a surviving spouse who is named as the beneficiary?

Answer: The RRSP can be rolled over to the surviving spouse's RRSP or RRIF on a tax-deferred basis

When a surviving spouse or common-law partner is the named beneficiary, the RRSP balance can be rolled over to their own RRSP or RRIF without triggering immediate income tax, deferring the tax until withdrawal.