... or is it decade?
On July 18 2017, the Department of Finance quietly introduced a consultation paper, explanatory notes and proposed tax changes (137 pages in all), aimed at Canadian private corporations and their shareholders.
The changes were, in the Finance Minister’s words, “closing tax loopholes and making sure all Canadians pay their fair share ..”
Translation – the proposals represented the most significant and complex changes and tax increases to our tax system in decades.
What happened?
The Minister announced a consultation period (till October 2 2017) to tell him, as he put it, “where we have it right, and where we can make improvements”.
What followed was a public outcry, widespread media coverage and representations by business and other groups.
The Department of Finance received more than 20,000 individual, written submissions, including some that were more than a 100 pages long!
During the week of October 16 2017, in a series of news releases, the embattled Finance Minister provided updates indicating that some of the proposals would be dropped and draft legislation simplified.
On December 13 2017 the Minister released new draft legislation (changing the proposed changes) effective January 1 2018 ..all of two weeks before the end of the year!
Nuts and Bolts ..please!
By now, everybody has heard of “income sprinkling” and “TOSI (tax on split income)” and “passive investments” and “kiddie tax”.
At a simplistic level, the government did not like the following tax strategies:
- Income Splitting – sharing corporate income with family members who are in lower income and tax brackets, thus reducing the family tax burden
- Multiplication of the Lifetime Capital Gains Exemption (LCGE) – whereby each family member, including minor children, could potentially claim the LCGE
- Holding Passive Investments – tax-paid funds retained and invested inside a private corporation. Generally the corporate tax paid is lower than personal tax rates. The government proposed higher tax rates on income generated from such investments.
- Converting Income into Capital Gains – latter is taxed at a lower rate! An anti-avoidance rule has been in place to prevent such conversions. However, the government was concerned that the rule is not effective.
Should I be concerned?
- Income Splitting – YES
- ..if your corporation pays dividends to a lower income spouse and/or adult children.
- As of January 1 2018, remuneration (including dividends) paid to family members will be subject to a stringent set of “reasonableness” tests, based on labour and capital contributions and active engagement (at least 20 hours per week) in the business.
- The onus of proving “reasonable” is on the taxpayer. Excess remuneration will be taxed at the top marginal rate of tax.
- Multiplication of the Lifetime Capital Gains Exemption (LCGE) – NO
- The government is not moving forward with proposals to curtail the LCGE, possibly due to unintended consequences upon transfers of family businesses to the next generation.
- Holding Passive Investments – MAYBE
- In the October 2017 update, the government has indicated that upto $50,000 of income earned annually from passive investments will not be subject to tax increases.
- The new rules will be applied on a “go-forward” basis, and existing investment portfolios will be “grandfathered”.
- This is a complex area, and the only certainty, it seems is “nobody really knows how to implement the proposals”
- Draft legislation however, will be released with the March 2018 budget
- Converting Income into Capital Gains – NO
- The government is not moving forward with its proposals, which in some instances could have resulted in double taxation on death of a shareholder
NOTE – Decrease and Increase in federal tax rates!
Effective January 1 2018, the federal small business corporate tax rate will be reduced from 10.5% to 10%. In turn, the personal tax rate on dividends (non-eligible variety) will INCREASE to maintain the tax integration system.
Provinces have not announced any changes to provincial tax rates
What should I do…
- Evaluate your personal and family situation first. Remember for instance, you can still pay reasonable salaries to family members for services provided. The rules have not changed.
- Pay additional dividends in 2017 to spouse and adult children who are in lower tax brackets. While this may result in a prepayment of tax, the lower tax rate benefits may more than offset the cost of tax prepaid.
Such payments in 2018 may be subject to the highest marginal tax rates, under the new income splitting rules. - Consider investment loans – individuals can borrow money (at a fixed prescribed rate of 1% currently) to invest in marketable securities. Income and gains arising from the securities are taxed in the hands of the borrower, regardless of age.
- Ensure each shareholder of your corporation owns a different class of shares, to provide maximum flexibility in payment of dividends.
- Planning around the passive investments spectrum currently, may be premature.
- Use available opportunities – for instance, family trusts remain a powerful vehicle, particularly for transfer of assets to family members, on a tax-deferred basis.
Finally
Let’s discuss your specific situation.
The “simplified” rules are quite complex in certain areas, and subject to interpretation.
