The Government of Canada has now released draft legislation to implement their summertime proposals around splitting income from small businesses with family members. They have made some concessions to the uproar that resulted from their original proposals in the interests of “simplification”.
The changes will apply to Dividends, Interest, and certain Capital Gains received by certain adult family members from a private corporation, either directly or indirectly. These income items will be taxed at the top tax rates in the hands of the recipients, unless they fall within certain Exclusions.
So how is income excluded from this extra tax?
For all adults, income and capital gains earned in a particular year from a related business will be excluded from the rules. A related business is a business in which the person has been “Actively Engaged” in its operation in the year income is received or in any five previous tax years.
“Actively Engaged” means working at least 20 hours per week during the part of the year that the business operates. The 5 years do not have to be consecutive.
So, if you own shares of a company that you actively work in, the company will be an Excluded Company and the additional tax will not apply to you. Similarly, if your spouse or adult children also meet the active work test, their income or capital gains would also be excluded.
If you are 25 years old or older, you might be able to avoid the extra tax if you meet the following criteria:
• You own 10% or more of the voting shares and those shares own more than 10% of the value of the company. These shares must be held directly, they cannot be held through a trust.
• The company must meet all of these criteria
• It cannot have 90% or more of its revenue from services. In other words, the company must have more than 10% of its revenue from the sale of goods or some other source other than services.
• The corporation is not a professional corporation (accountant, dentist, medical doctor, veterinarian, or chiropractor).
• It is not getting most of its income from a corporation that would otherwise qualify under this rule (holding company owning shares in an operating company)
If you are between 18 and 24 years old:
• You will need to have worked in the company at least 20 hours per week in the taxation year, or any five prior years. Those 5 years do not need to be consecutive. The work, however, will need to be regular, continuous or substantial in order to qualify, …or
• You can receive a return on money invested into the company. The rate of return will be specified by the legislation.
If you are over 65 years old:
If you have made a significant contribution of labour, capital or assumed risks in the business for at least five years, and are over 65 years of age, your spouse can receive income from the company without the extra tax, no matter what their age.
Gains on the sale of shares that qualify for the Lifetime Capital Gains Exemption (together with qualified farm and fishing property) will not be affected by the changes. However, the July proposals to apply the extra tax on other shares remains.
This commentary is intentionally general and is designed to bring to light the basics of these new rules. The detailed changes are extensive and will apply differently in each situation.
We continue to review the proposals and will have a better sense of what they will mean to clients early in the New Year. Please give us a call if you have any questions that relate to your specific circumstances.
RHN Management and Staff