The federal government is providing Canadian small-business owners a large measure of relief from its previously signalled changes to the taxation of passive investment income held in a small businesses as part of Budget 2018.
In fact, Ottawa is proposing a simpler regime that limits access to the lower small-business rate for corporations rather than taxing passive income above $50,000 at potentially punitive tax rates, as the government proposed last year.
“It’s a complete reversal of the [original] plan,” says Jamie Golombek, managing director of tax and estate planning with Canadian Imperial Bank of Commerce’s wealth strategies group in Toronto. “This will be much easier for small-business owners to digest. I’m not saying that everyone is going to love it, but it will be far simpler to implement.”
The government now proposes that when a corporation earns more than $50,000 of passive income in a year, the amount of income eligible for the small-business rate would be reduced gradually. Passive investment not eligible for the small-business rate would be taxed at the general corporate income tax rate.
The government is proposing that the small-business deduction limit be reduced by $5 for every $1 of investment income above the $50,000 threshold, which would be equivalent to $1 million in passive investment assets at a 5% return, the government says. Under this proposal, the small-business deduction limit would be reduced to zero at $150,000 of investment income, which would be equivalent to $3 million in passive investment assets at a 5% return.
The proposed changes announced in the budget are good news for a small-business sector that had been concerned over previous proposed regimes that it said would see entrepreneurs and incorporated individuals lose the ability to build up a retirement fund, or save for future investments into a business, by retaining passive investment income in private corporations, Golombek says.
Small-business owners might also consider whether it would make sense to adjust their portfolio of investments held within the small business.
“There will be ways to minimize the impact of the changes, using perhaps a long-term buy-and-hold strategy, which doesn’t recognize annual income and defers all income to the future,” Golombek suggests.
The government also proposes in Budget 2018 that private corporations no longer be able to obtain refunds of taxes paid on investment income while distributing dividends from income taxed at the general corporate rate. Refunds will continue to be available when investment income is paid out.
The government said that these two proposed measures — limiting access to the small-business rate and to refundable taxes for larger private corporations — will achieve the goal of limiting deferral advantages from holding passive savings in a corporation.
However, the measures will do this “in a more targeted and simpler manner than was first proposed in July 2017,” when the original proposals were first announced, the budget documents state. Both measures will apply for taxation years that begin after 2018.
“The government has engaged Canadians in an open dialogue on tax planning strategies using private corporations, and has listened to their feedback,” the government added in the budget document.
In total, and in combination with the government’s previous announced changes to the income sprinkling rules, which became effective on Jan. 1, the government says it expects to raise $3.4 billion over six years — from the 2017 to the 2023 taxation years — from these measures.