October 2, 2017 marked the end of the Liberal government's 75-day consultation period on proposed tax reform for private corporations. The reaction to this proposal was swift and may have caught the Liberals off guard. That's why it's not surprising that changes to the tax reform plan were announced only two weeks after receiving some 21,000 submissions!
We thought it would be useful to outline what has changed since the proposal was originally unveiled in July.
Small business tax rate
The Government has indicated that it intends to bring down the federal portion of the small business tax rate from 10.5% to 9%. This will be done over two years as follows:
January 1, 2018 - the rate will drop from 10.5% to 10%
January 1, 2019 - the rate will drop from 10% to 9%
The Government is moving forward with limitations on income sprinkling through dividends to family
members. However, the Government has emphasized that a family member who makes a meaningful contribution will still be entitled to receive a reasonable amount through dividends. "Meaningful contribution" and "reasonable amount" have yet to be defined. We expect that the specifics will be determined by future CRA interpretations, and ultimately the courts.
Access to the lifetime capital gains exemption
The Government will not limit access to the lifetime capital gains exemption. Consultations showed that there were unintended consequences for family groups. This is good news as many corporate structures have set up trusts in order to facilitate intergenerational family transfers or to tax effectively sell their corporation. Now these structures can remain in place.
Passive income investments within the private corporation
One of the most contentious changes was the intent to heavily tax passive income earned in a corporation on a go forward basis. The proposal was to grandfather in any existing surplus and tax any new surplus earned from active businesses invested in the corporation with an additional 38.3%. (This was handled by limiting the refundable tax when paid out as a dividend). The intent of this change was to eliminate any tax deferral advantage that came with investing in a corporation.
The Government determined that instead, there would be a safe harbour for the first $50,000 of investment income. This means that the proposed additional 38.3% tax would not apply to the first $50,000 of income in the corporation earned from investment income. This amount was chosen because it was determined to be equivalent to $1,000,000 invested, earning 5% interest annually. They will continue to grandfather existing investments.
What remains unclear is when the date of this change will take effect. Also not clear is how the $50,000 will be calculated. For example, capital gains have a 50% inclusion rate for income tax purposes, but does that imply you can earn $100,000 in capital gains as it is only $50,000 of income?
Regardless, now more than ever, it will be important for investment advisors and accountants to
communicate with respect to planning.
Converting dividends to capital gains
Stripping surplus out of a corporation and converting dividends to capital gains involves a number of tax planning steps. One of the proposed changes involved curtailing this planning.
However, the proposed changes had many unintended consequences, including significant negative impacts on estate taxes. As a result, the Government has decided not to proceed with the proposed changes and will allow this planning to continue for the time being.
These changes have created an environment with a large degree of uncertainty. We anticipate more
changes are coming. Should you want to discuss your situation and how the above may impact you or your business, please contact us to arrange a meeting.