Finance Proposes Significant Negative Tax Changes For Canadian Entrepreneurs
JULY 20, 2017
The 2017 Federal Budget suggested possible changes to legislation affecting common tax planning techniques for entrepreneurs. This week the Finance Department introduced proposed legislation and announced it was starting consultations with the public. Although early in the legislative process and any final legislation may be different than what has been proposed, the proposed legislation would yield significant changes for owners of private corporations.
Reduced Income Sprinkling
Application of Split Income Tax
There are split income tax rules currently in place (referred to as the “kiddie tax” rule as they currently are in place only for minors) which have the impact of split income being taxed at the highest marginal rate and not the effective rate of the individual reporting the income.
Under the proposed rules:
– The application of the split income tax is being expanded to
o remove the age barrier (the tax could apply to adults as well as minors)
o at any time during the year an adult receives income derived from the business of a related, Canadian resident, individual
– The types of income to be classified as “split income” has been expanded to include income such as capital gains from certain property after 2017 where that property earned income to which split income applied, and compounding income for recipients under 25 (income from monies on which split income tax was paid)
A simple example would be an adult child receiving a dividend on shares of a corporation owned by the child’s parent.
There is a reasonability test whereby, if the payment received is reasonable compensation that would have been paid to someone who was at arm’s length, then the amount would not have the split income tax apply. This is to allow for family who are actively involved in the business to be reasonably compensated.
Constrain multiplication of the capital gains exemption
The impact of these changes is to prevent multiple family members to access their lifetime capital gains exemption.
On dispositions after 2017 (though there are transitional rules to be aware of):
– in order to claim a capital gains exemption, the individual would have to be the age of 18 or older at the end of the year
– the exemption is not available to the extent the taxable capital gain would be included in split income per above and
– No exemption would be available related to gains accrued during the time property was held by a trust, subject to certain exceptions (spousal or common law trusts, employee share ownership trusts)
The proposals also include anti-avoidance rules to prevent taxpayers from removing corporate surplus in the form of capital gains by converting certain gains realized between non-arm’s length parties to deemed dividends.
The Finance Department provided comment on their intention to increase the tax rate payable by private corporations on after tax funds of active business which are not reinvested in the active business, but instead into passive investments. There are various potential approaches noted which are quite complex, though all work to increase this tax rate.
The consultation period provided by the government is scheduled to close in early October. If you would like to provide your views directly to the government, you can do so by e-mailing to email@example.com.