As a freshly-assigned team leader in a small commercial lending division in another town, years ago, I introduced myself to my group by purchasing a dozen doughnuts from a local bakery.
In an effort at ice-breaking humour, I took a bite out of each doughnut, then made a big fuss about the generous gift to the staff.
Thud went the joke, and my first day of leadership.
But this inspired a staff member (and friend of the baker) to bring in a dozen doughnuts of her own, which had been cleverly custom-filled... with mustard.
Touch.
As it turned out, we had a small, tight-knit group, and I remember that period with fondness.
The most junior of the team was a little nervous about a particularly anxious borrower one day. This gentleman had been a notoriously bad risk in the past, but couldn't take no for an answer.
He cycled through the various levels of the bank, re-applying for a small business loan he was determined to get. His primary argument was not a business case so much as dire a need for the money for his group. But if whining is your primary craft, you stink as a business partner.
So in another attempt at humour I made a sandwich board that said: "Just say no," and marched casually past her office during the interview, careful to catch her eye, and not the client's.
To her credit, she managed to withhold her giggles, and our money at the same time.
And so we, in professional investment and lending circles, tend toward the data, and not so much the cause. There are times when the cause comes in to the decision, but only when the data supports the business case.
One example of this concept is labour sponsored investment funds.
Other than an RRSP contribution, another strategy for reducing your income tax liability after the end of the taxation year is to make a labour sponsored investment fund purchase within the first 60 days of the following taxation year, but don't.
Labour sponsored investment funds (or LSIFs) invest primarily in small to mid-sized private firms which require this funding for development or expansion. As such, these investments are considered to be high risk (because the typically small, start-up firms have a higher failure rate).
Costs of LSIFs, similar to mutual funds, include management fees. Most of the investments are in private companies where information may not be readily available, so the research expenses are quite high.
As a result, the management expense ratio of LSIFs is typically higher than mutual funds.
Other costs include performance fees to reward the managers if the fund performs well, sales commissions and early redemption fees. But the biggest cost of all is poor performance.
In order to encourage investing in these small and mid-size Canadian firms, federal and provincial governments have created tax advantages for investing in LSIFs. A federal tax credit of 15 per cent on the first $5,000 contribution (i.e. the annual maximum federal tax credit of $750), and up to another 15 per cent in B.C. tax credits exists. If you purchase a LSIF within the first 60 days of the year (inclusive), these tax credits may be taken on your immediately preceding taxation year's tax return or current year's tax return, similar to an RRSP.
Other important issues that you should be aware of regarding LSIFs are:
LSIFs are designed to be held for at least eight years. If an investor redeems their investment within eight years, the federal and provincial tax credits will be withheld from the proceeds and repaid to the governments by the fund company.
LSIFs purchased in an RESP, RIF, LIF, LRIF or PRIF will not receive any federal tax credits. Provincial tax credits in this case will likely also not be received, however individuals must check with each specific fund company;
Either spouse can claim the tax credits for LSIFs purchased in a spousal RRSP;
Unused LSIF credits cannot be carried forward to a future tax year; and
If an individual's tax payable is less than the LSIF tax credit, the individual will only be able to use the credits to reduce their tax payable to nil. The excess unused tax credits will be lost forever.
Canadian Business Magazine cited that returns for LSIF's "...have rarely, if ever, been competitive... Even the Fonds de solidarit des travailleurs du Qubec, the $10.1-billion gold standard of Canada's labour-sponsored funds, has a 30-year annualized return of just 3.8 per cent."
(And worse, the fund was linked to organized crime).
The tax advantage of purchasing a LSIF must be weighed against the investment merits and the requirement to hold the investment for at least eight years.
It is very important to consider the quality of the investment, and not just the potential tax credits.
As the saying goes, "A good tax shelter that is a bad investment is a bad tax shelter."
So, yeah, just don't.
Mark Ryan is an investment advisor with RBC Dominion Securities Inc. (Member - Canadian Investor Protection Fund), and these are his's views, and not those of RBC Dominion Securities. This article is for information purposes only. Please consult with a professional advisor before taking any action based on information in this article. Ryan can be reached at mark.ryan@rbc.com.
