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Update on Proposed Tax Changes

Posted By: Anonymous

By Nizam Shajani, CPA, CA, MBA, Partner

On July 18, 2017 Finance Minister Bill Morneau and the Department of Canada released a summary overview of changes to the tax planning used by private corporations – with a disparaging undertone indicating that small and medium sized business owners were taking advantage of tax loopholes and not paying their fair share of tax.

Three areas were highlighted for change with a relatively short consultation period that ended October 3rd, 2017.  The highlighted areas included:

  1. Income splitting
  2. Passive Investments
  3. Intergeneration transfers

This was not well received by business groups and industry representatives and the Minister was put in a position to admit the proposal was plagued with “unintended consequences” and needed farther review by industry experts. 

Since then there has been back tracking, reinstatements of the proposed plan and then some more tweaking.  The inconsistencies and lack of clarity have been disappointing.  However, here is the most recent developments.

Tax Rate Decrease

There has now been a proposed small business tax rate decrease at the federal level.  As a background, the proposed decrease was introduced as a series of decreases by the previous government and included (to be retained) as a campaign promise by the current government.  However this was abandoned as part of the 2015 budget.  It has now been reintroduced to quell the outrage by small and medium sized business owners at the proposed tax changes and the related consequences. 

 

Current 2017

2018

2019

Federal rate

10.5%

10.0%

9.0%

Alberta rate

2.0%

2.0%

2.0%

Total corporate tax

12.5%

12.0%

11.0%

Income Splitting

The proposed reasonability rules for income splitting or sprinkling is likely to stay and effective January 1, 2018.  There are already rules in place to address salaries and wages to family members – requiring work to be done and the compensation to be reasonable.  The addition of income sprinkling rules would therefore be addressing dividends to family members as investors in the small business.  While dividends are paid to shareholders who have invested in the company – the result of the proposed rules would provide an incentive to invest in large corporations (that would not have the same limitations) over a small business.  There also seems to be no concern over the legal rights to a return via dividends of shareholders who have made those initial investments in family run businesses. 

However the proposed rules were also to be extended to the $835,720 in lifetime capital gains exemption each shareholder is able to receive on the sale of their shares of the corporation.  This had many business owners and farmers concerned.  This portion of the proposed income sprinkling rules are being abandoned. 

Passive Income

 The proposed rules were also to extinguish the integration rules on passive investment income earned by small and medium sized corporations.  The exiting rules allowed a small business to invest in passive income such as real estate or dividend and interest paying stocks and not have to double pay tax.  For instance – the large corporation that a small business had invested in would pay corporate tax at the large business rate on those earnings.  The earnings are then distributed to the small business as it is a shareholder.  The small business is then charged a refundable tax at the large corporate tax rate and then refunded that tax when those dividends are distributed to its individual shareholders.  The individual shareholders would then pay personal tax on the dividend.  The rules are in place so that an individual who receives passive income pays the same rate of tax as the business and then ultimately the shareholder who received the same amount of passive income. 

The prosed rules were to take the refundable portion of the tax away from small business owners who earned passive income.   As a result – integration is lost and becomes punitive for a business to earn passive income.  As a comparison – a small business owner would be subject to up to 69.1% tax rate on passive income compared to up to 48% for an employee based on amounts available to invest from the same dollar of earnings. 

The passive investments rules are to be revised under the new proposed rules for passive income in excess of $50,000 in the small business corporation. 

Intergenerational Transfers

This proposal was to restrict the intergenerational transfer of a corporation to related parties – deeming what would otherwise be capital gains to dividends.  It seems that proposal is being abandoned.  

This information is for discussion purposes only and should not be considered professional advice. There is no guarantee or warrant of information on this site and it should be noted that rules and laws change regularly. You should consult a professional before considering implementing or taking any action based on information on this site. Call our team for a consultation before taking any action.

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