Back in July, the Department of Finance proposed tax planning changes for private corporations with an intent to add more fairness to the Canadian Tax System.
The proposed changes focused on three specific tax planning strategies:
- Income sprinkling using private corporations
- Holding a passive investment portfolio inside a private corporation
- Converting a private corporation’s income into capital
However, after receiving substantial backlash in the form of 21,000 submissions during the 75-day consultation period, ending October 2, 2017, the Government is announcing a number of changes to tax planning for Private Corporations.
A new approach will be taken that better targets the relatively small segment of high-income individuals, that the Government believes are receiving the biggest advantage from current tax rules.
Income Sprinkling Using Private Corporations
Income sprinkling 'consists of sharing business income among family members - whether or not they're involved in the company - through dividend payments.'
In the July Proposal, the government propositioned that Income Sprinkling needed to be better distinguished from reasonable compensation for family members. This was to be done by:
- Extending the tax rules regarding split income
- Limiting the multiplication of the lifetime capital gains exemption (LCGE)
- Supporting measures to improve the administration of the income tax rules to address income sprinkling
In addition, a reasonableness test based on four basic principles, was recommended for determining whether family contributions qualify. The four principles include: labour contributions, capital or equity contributions to the business, taking on financial risks of the business, and past contributions.
Concerns were raised about the complexity and possible inadvertent consequences of the changes.
In response, the government will simplify the changes to ensure fairness for family members who are making real contributions to their family business.
In addition, the previously proposed changes to the Lifetime Capital Gains Exemption will not go forward, however, it is unknown whether the Lifetime Capital Gains Exemption will be subject to the reasonableness test.
Holding A Passive Investment Portfolio Inside a Private Corporation
Currently, individual income is taxed at higher rates than corporate income. This is done in an attempt to promote business investment and growth. However, tax deferral advantages can be realized when the corporation’s owner uses income taxed at the lower corporate rate for passive investments.
In the July Proposal, the government set out measures for minimizing opportunities for tax deferral.
The government intends to move forward by creating DRAFT legislation for the 2018 Budget, with consideration to the following:
- Changes will be made on a go-forward basis
- Funds needed for future investment or contingencies will be protected from the new legislation
- There will be an income threshold of $50,000 for passive income, allowing for more flexibility
- Incentives for venture capital and angel investors will be maintained (it is not specified how this will be achieved)
- Changes will not apply to AgriInvest
Converting A Private Corporation’s Income into Capital
The government is proposing changes to Private Corporations ability to convert income into gains capital. However, due to unintentional negative consequences these changes could have for small businesses and farms, the government will be reviewing the proposed changes.
Small Business Tax Reduction
While this was not discussed in the July Proposal, the Government has proposed to reduce the federal small business tax rate from 10.5% to 10% in 2018 and from 10% to 9% in 2019.
This reduction was initially legislated by the previous government but was frozen in the 2016 Federal Budget.
This change could result in $7,500 in savings for eligible small businesses.
For more details on the July 2017 Proposal and the recent changes, read Grant Thorton’s Proposed Changes: Tax Planning Using Private Corporations and Government Announces Changes for Private Companies in Response To Recent Tax Proposals.
