Proposed Tax Changes for Canadian Private Corporations

October 5, 2017 RHN CPA No Comments

By now you have read and heard of a large volume of information related to the Federal Government’s proposed legislation to tax individuals and their small business corporations. We have provided a summary below. RHN has studied the proposals. The proposed changes are just that – proposed changes. The Government has requested submissions from interested parties to provide input for their consideration. There have been many parties, including our governing body, CPA Canada, that have made submissions.

Although it is difficult to recommend any significant changes to your structure without knowing the actual rules, RHN invites you to meet with us to review how these proposed changes might impact you. There are some steps that can be taken under certain circumstances and we have some ideas in this regard. If you wish to discuss your situation please contact us to set up an appointment in the coming few weeks.

Proposed tax changes
Canadian private corporations, including many small businesses and Personal Professional Corporations, are familiar with the current taxation rules which have been unchanged for decades. However, as announced by the Canadian federal Finance Minister, Bill Morneau, on July 18, 2017, there is proposed draft legislation which, if enacted, will have a dramatic impact for these private corporations. Here are the key areas in the proposal:

Key change 1 – Income splitting
Since 1999, tax rules (known as the tax on split income (TOSI) or “kiddie tax”) have been in place to prevent income splitting with children under the age of 18 (i.e. using minor children to reduce the income earned by adults, thus reducing overall income taxes). Under these rules, minor children are subject to tax at the highest marginal tax rate on, amongst other things, dividends received from private corporations.

Proposed changes under new legislation (starting in 2018):
– The existing income splitting rules will also be applied to income splitting with adults.

– Beyond private corporate dividends, income splitting rules will be expanded to include 1) income from certain debt obligations, (2) capital gains from the sale of shares the income from which is subject to the TOSI and (3) compound income on property that is the proceeds from income previously subject to the TOSI rules or the income attribution rules.

– A reasonableness test will be used to determine how much contribution a family member actually makes to a business to be exempt from the increased tax rate. The factors used will be (1) contribution of labour, (2) contribution of capital and (3) previous returns/remuneration.

– A higher standard of reasonableness is proposed for individuals between the ages of 18 and 24 rather than those over the age of 24.

Key change 2 – Lifetime Capital Gains Exemption
Family trusts are often used to own shares in a private corporation. Each beneficiary of the family trust has the ability to utilize their capital gains exemption on the sale of the corporations’ shares. In BC the tax savings from claiming one capital gains exemption is approximately $195,000.

Proposed changes under new legislation (starting in 2018):
– Individuals under the age of 18 will not be allowed to make use of the capital gains exemption.

– Beneficiaries of trusts will no longer be allowed to make use of the capital gains exemption with respect to gains on the value of shares that accrue during the period in which the trust holds the shares.

– Individuals who are subject to the TOSI with respect to a share will not be able to make use of the capital gains exemption on the sale of such shares.

Key change 3 – Passive investment income
Many individuals currently choose to leave excess earnings inside a corporation (rather than taking all earnings out as salary or dividend) and allowing the excess earnings to grow in a passive portfolio or transfer it as tax free intercorporate dividends to a connected company and invest it there.

Proposed changes under new legislation (starting in 2018):
– The government is exploring how to limit the perceived benefit of leaving excess earnings inside a corporation to grow in a passive portfolio. The draft paper does not specify the actual measures being proposed to limit this benefit. It has, however, identified some possible approaches and invites input from interested taxpayers as to how to design new rules, with the goal of “to tax corporate passive income in a way that is fairer for Canadians”.

Key change 4 – Converting income into capital gains
Amendments are proposed to the anti-surplus stripping rule in section 84.1 of the Income Tax Act. This is to prevent a shareholder from extracting retained earnings from a private corporation as a capital gain rather than as salary or dividend which is beneficial to the shareholder, as capital gains are taxed at a lower rate than dividends.

What does it mean to Canadian private corporations?
The draft legislation announced on July 18, 2017 is currently, as it states, a draft. These proposed changes will not take effect until the draft legislation has gone through a number of specific stages in the House of Commons and the Senate before it becomes law. Shareholders of Canadian private corporations and businesses are encouraged, at this point, to examine their own corporate structure and identify what impact these potential changes may have on their current tax structure and strategy.

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