Paul and his wife have a non-registered investment account and want to make sure they are reporting the income correctly on their tax returns.
Q. My wife and I sold our home two years ago that was in both our names and we opened up a non-registered account in both our names (JWROS—joint with rights of survivorship). Both of us are authorized to trade on the account, and any dividend income received has both our names on the yearly slip we get from our brokerage. This way, we simply split all dividend income 50/50. The CRA has had no issues with this arrangement.
The only money that has ever been transferred into this account has been the proceeds from the sale of our jointly owned house. We have had no capital gains since opening the account, but are curious about how to report capital gains when the time comes to sell a holding. Can we split this, or would only one of us enter this on our tax return?
A. An important concept with investments and other assets is the distinction between legal and beneficial ownership. If two people’s names are on an investment account, like you and your wife, Paul, you may legally own the account as joint tenants with right of survivorship. This means if one of you dies, the account passes directly to the survivor.
There is another type of shared ownership called tenancy in common, often used for real estate. This is when two or more people own an asset together, but there is no right of survivorship. This is more common when siblings own an asset, or when married or common-law spouses in a second marriage own an asset together. Upon death, the share of the deceased can be distributed based on their will rather than being made over to the survivor.
Regardless of how an investment account is held between spouses, there is a tax concept called attribution that may apply. Attribution is when income earned by one spouse is attributed back to the other spouse and taxable to them. Simply adding a spouse’s name to an investment account does not circumvent attribution. Future interest, dividends, capital gains and other income may be attributable back to the first spouse.
There are legitimate ways to avoid attribution. A spousal loan at the Canada Revenue Agency (CRA) prescribed rate of interest, currently 1%, can be used. A trust can be established with funds loaned at the prescribed rate. Or, with careful tracking, the second-generation income earned—income on the initial income—may avoid attribution.
Paul, your question distinguishes between the dividends you have reported in the past and the capital gains you may report in the future. The CRA does not treat different types of investment income differently when considering attribution between spouses. Both dividends and capital gains are subject to the attribution rules.
I should also point out that just because CRA has accepted your previous tax returns as filed and has not asked questions—or has not asked them yet—it does not mean they agree with the position you have taken on your tax return. I have seen tax returns with significant investment income reported by stay-at-home spouses and where taxpayers have taken a questionable stance with attribution, sometimes inadvertently.
Many spouses have joint non-registered investment accounts and split the income equally on their tax returns. Technically, if they did not contribute equally to the account, the split should be something other than 50/50. Practically, the 50/50 allocation is common.
In your case, Paul, the house proceeds are even more complicated. The original purchase was funded with a down payment. Did you both contribute equally to that down payment, or in some other proportion? Over the years, you made regular mortgage payments. Did you both contribute equally to those mortgage payments? You may have done renovations. Again, who paid? And finally, what about that inheritance you used to make a lump sum payment against your mortgage? You get the idea. The actual split of whom the house proceeds belong to for tax and attribution purposes is difficult to determine for either you or the CRA.
You should try to come up with a reasonable allocation between you and your wife, Paul, and that may well be a 50/50 split. That split would apply to all types of income earned within the account. The split should apply every year, so you cannot pick and choose whom to allocate income to from year to year.
It should be noted there are ways to document things for tax purposes so that you do not need to rely on the ratio of one spouse’s income to another. In other words, you could have a higher-income spouse pay for household expenses and a lower income spouse contribute to a non-registered investment account. This could be documented by maintaining separate accounts. In this way, you could have a non-registered account taxable entirely to one spouse despite them having the lower income.
CRA has rules in place when it comes to taxable investment income and spouses, and these need to be considered. Families should try to structure their affairs to pay the least amount of tax. In this way, you can more quickly become and remain financially independent while staying on the right side of the tax man.
Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto. He does not sell any financial products whatsoever.