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Reducing your Tax Bill through LSIFs

As you know, Canada's tax burden is substantially higher than in many other countries including the United States, the United Kingdom, Australia, Switzerland and Japan. With almost half of your earnings each year going towards your total tax bill, it makes sense to try to minimize the tax bite as much as possible.

One effective way of tax-efficient investing is through retail venture capital funds, known as labour sponsored investment funds (LSIFs). Retail venture capital funds offer tax credits of up to 35% and are RRSP eligible.

Venture capital funds invest primarily in the shares of private small and medium-sized Canadian high growth companies. These funds offer the potential for superior returns over the long-term and the added value of attractive tax benefits. The down side to this is that LSIFs must be held for a minimum of eight years, or the tax credit must be repaid.

Ontario taxpayers are entitled to a tax credit of up to $1,750 or 35% of the first $5,000 invested in this asset class each year, with the Federal Government offering a 15% tax credit and Province of Ontario offering up to 15% in tax credits. To increase the benefit even more, an LSIF held within a registered retirement savings plan (RRSP), gives you the added advantage of decreasing your net income for tax purposes. For example, an investment of $5,000 invested within an RRSP would result in a $1,750 tax credit and additional savings of $2,320 for an investor falling within the top tax bracket, with a marginal tax rate of 46.4%. By investing $5,000, you end up with your initial investment, as well as $4,070 in tax savings to do with as you wish.

To further reduce your tax hit, and make your investment work twice as hard for you, reinvest your tax savings. If you end up with a $4,070 refund due to the credits and RRSP deduction, that $4,070 can be used towards your RRSP for the following year. At a 46.4% tax rate that $4,070 investment would result in another $1,888 tax deduction and you will have another $4,070 compounding over time.

Although LSIFs can be a great addition to a diversified long-term portfolio, they can be risky investments. While most of these funds' returns have been acceptable, some have not fared well and a few have lost most of their capital. Investors should consult a Financial Advisor, to determine which fund would be best suited for them.

*Please note: Using Labour Sponsored Funds with a 30% tax credit and/or investors with a lower marginal tax rate will change the above figures proportionately.

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