Previously, we discussed proposed changes to passive investment income earned by private corporations detailed in the 2018 Federal Budget.
The changes proposed two new measures. The first is a reduction of the business limit for passive income earned over a specific threshold and the second will limit the refundability of taxes paid on investment income.
To find out more about what the changes are and how they could affect you, keep reading.
Business Limit Reduction
Currently, small businesses are provided a lower business tax rate on up to $500,000 of active business income. Originally, this tax benefit was provided to help support small businesses that have a harder time accessing capital, allowing them to reinvest more money back into the business. Unfortunately, companies began taking advantage of this deduction, using it as a tool for accumulating a large amount of passive income.
In response, the 2018 Budget proposed that the business limit of $500,000 be reduced where a group of associated Canadian-Controlled Private Corporations (CCPCs) earn a substantial amount of passive income.
Where adjusted aggregate investment income is between $50,000 and $150,000 ($1 million to $3 million in passive investment assets) the business limit will be reduced by $5 for each $1 of investment income earned in the previous year, being reduced to nil if this income is $150,000 or more. If the adjusted aggregate investment income is below $50,000, no reduction will occur.
When determining the adjusted aggregate investment income, the following adjustments will be required:
Additions
- Dividends received from non-connected corporations
- Savings income attribute to a life insurance policy that is not exempt (some exceptions apply)
Subtractions
- Taxable capital gains arising from the disposition of assets used primarily for active business carried on in Canada by the company or a related CCPC
- Taxable Capital Gains arising from the disposition of shares in a connected CCPC where the fair market value attributed to assets used in active business in Canada
- Net Capital Loss Carry Forwards
In addition to the above changes, anti-avoidance measures will be put in place to discourage questionable transactions, such as transferring property to a related but unassociated CCPC.
Refundability of Taxes on Paid on Investment Income
At present, investment income of private corporations is taxed at a greater rate, but a refund can be recognized when this income is paid out as dividends to shareholders. However, under these same rules, a lack of limitations allows a tax refund whether those dividends are paid from investment income or active business income, which is taxed at a lower rate. As a result, CCPCs have been benefiting from a perceived tax advantage, where lower-taxed dividends are paid from active income and a refund is claimed for taxes paid on investment income.
To prevent this from happening, the 2018 Budget proposes that refunds resulting from refundable dividend tax on hand (RDTOH) will no longer be available for eligible dividends. Instead, increased traceability will require corporations to match the refundable tax to the appropriate dividend and only receive a refund on non-eligible dividends.
While these changes concern only some of the small businesses eligible for the small business deduction and RDTOH, if you are one of those affected, it is important to understand what the changes mean for your overall tax strategy.
For more information on these changes and how they could affect you, contact us today.
