"Well meaning grandparents often make investments in their grandchildren's names to provide a future nest egg or to help defray the expected high costs of a College or University education."
education plans are sometimes used for the latter purpose but these have
some restrictions and the possibility of forfeiture of any income earned
if the funds are not used for educational purposes at a recognized institution.
Many grandparents therefore simply establish a bank account in the grandchild's
name or buy them a GIC
What are the income tax rules?The income tax rules that apply are called income attribution rules, and pertain to blood-related minor children. The blood-related definition includes children, grandchildren, great grandchildren and nieces and nephews. A minor in this case is a child still under 18 years of age at the end of the year.
The basic attribution rules for blood-related minors are:
1) All interest, dividends, and foreign income, earned on the principal amount invested is taxable in the hands of the person gifting the money (unless the gift giver is a non-resident). This is often referred to as primary or first generation income.
2) Future income earned on the first generation income is taxable in the hands of the child. This is called secondary or second generation income.
3) All capital gains earned on the investments are taxable in the hands of the child.
4) Income from investments funded exclusively from the child tax benefit or an inheritance is taxable in the hands of the child.
5) It is the gift givers responsibility to keep accurate records.
How can these rules affect you?
If you buy a single $5,000.00 GIC or CSB for a newborn
grandchild that earns 7% each year for the 18 years he or she is a minor,
the first generation income is $350.00/year (7% of $5,000.00) for a total
of $6,300.00 for the full 18 years.
What can you do to protect yourself?
1) Keep very detailed records if you buy GICs or CSBs for your grandchild.
2) Separate any interest earned on the investment into a separate account so that future interest is documented and taxed in your grandchild's hands.
3) Better still... consider using an investment where the main source of income is capital gains (remember capital gains are taxable in your grandchild's hands).
Since in most cases the investment will be long term, (up to 18 years),
consider using a growth mutual
fund where most of the return is in capital gains and long term performance
is often much better than GICs or CSBs.
The important thing to remember is that failing to properly report your tax liabilities can result in substantial penalties if Revenue Canada decides to investigate. Not knowing the rules is not a defense.
Have a question regarding this article? Use our feedback form to send us a note.
© , Fiscal Agents Money Management Newsletter