The federal government provided considerable relief to small-business owners last month when it announced it would be backtracking on several elements in its raft of proposed changes in taxing private corporations. Those proposals were initially released this past summer.
Faced with a fierce backlash from the small-business sector, Ottawa softened some of its original proposed changes, jettisoned others outright and announced that the small-business tax rate would be lowered.
Jamie Golombek, managing director of tax and estate planning with Canadian Imperial Bank of Commerce’s wealth strategies group in Toronto, calls the series of announcements regarding private corporation taxation that the government made in mid-October “a step in the right direction.”
Small-business owners aren’t out of the woods yet, though. Ottawa indicated that it remained committed to limiting certain tax advantages associated with the use of private corporations, focusing on those the government believes give an unfair tax advantage to wealthy Canadians.
Arguably, the primary issue for the government remains the “sprinkling” (a.k.a. splitting) of dividend income among family-member shareholders, the first of the three key areas of concern identified in the original consultation paper released on July 18.
The Department of Finance Canada now states it will release revised draft legislation regarding income sprinkling before the end of autumn, this time trying to provide greater certainty regarding the “reasonableness test” used to determine the tax treatment of dividends paid to family members.
In light of these anticipated changes, tax practitioners recommend that incorporated individuals should consider paying out extra dividends to spouses or adult children before the end of the year if those family members are not actively involved in the business and are in low tax brackets.
Next year, the government is expected to limit the opportunities currently available to small-business owners and entrepreneurs to split income with family members.
“The big opportunity right now is in dividend income sprinkling,” Golombek says.
Adds Dave Walsh, partner and tax service line leader and partner with accounting firm BDO Canada LLP in Ottawa: “We’ve been encouraging our clients to take advantage of the [dividend income splitting] rules to the extent that they can.”
In addition, business-owner clients who are considering either finalizing an “estate freeze” – a commonly used estate-planning technique for the tax-efficient transfer on death of a business to family members – or setting up a new business with funding or a guarantee from family members, should take into account the government’s proposed rules before proceeding, Golombek says. Both types of transaction may face unfavourable tax consequences under the proposed rules.
Regarding passive investment income earned in a private corporation, the second of Finance Canada’s three key concerns outlined in July, the government gave small-business owners welcome relief in mid-October in the form of an annual $50,000 exemption on income earned in a private corporation before any new tax regime applies. This exemption amount, the government said, will mean that only 3% of business owners would be affected by any new passive investment income rules.
“It’s a good thing,” Wilmot George, vice president of tax, retirement and estate planning with CI Investments Inc. in Toronto, says of the exemption. “It’s going to allow many private corporate owners not to have to worry about the passive investment income changes.”
In addition, the government reiterated that any changes to the taxation of passive investment income would be on a “go forward” basis, meaning that there would be full grandfathering of investments held in a business and any income earned on those investments. Finance Canada stated that it would be releasing draft legislation to implement passive investment income changes in the 2018 federal budget.
For business-owner clients, the key takeaway, Golombek says, is that there’s no need to withdraw current investments from the business in anticipation of the government’s changes, thanks to the grandfathering provision.
“The government will be targeting only income earned after a certain future date [when any new legislation would come into effect],” Golombek says, “and, even then, only above $50,000 earned in a year.”
However, in light of these proposed changes, business owners might consider directing future investment income from a private corporation toward paying themselves a large enough salary to maximize contributions to RRSPs and TFSAs.
Other options, should the government proceed with its proposed changes to the taxation of passive investment income, could include establishing an individual pension plan or buying corporate-owned life insurance.
Finally, the government elected to scrap the proposals related to the third of its three areas of focus: the conversion of income into capital gains. Stakeholders had raised concerns with the proposals related to the inter-generational transfers of businesses, among other issues.
“The government decided that it would be too difficult to try to achieve what it wants to achieve in a short period of time with its proposal,” George says. “So, [this proposal] has been taken off the table.”
The government’s decision to lower the small-business tax rate from 10.5% to 10% in 2018 and to 9% in 2019 is likely to please incorporated clients, Golombek says.
The irony, however, is that lowering the small-business tax rate only makes certain tax planning strategies using private corporations more attractive, he adds.
“The bigger the gap between top personal rates and the small-business rate,” Golombek says, “the higher the tax deferral advantage.”
© 2017 Investment Executive. All rights reserved.