On July 18, 2017, the Department of Finance Canada released a consultation paper and draft legislation on the use of various tax-planning strategies through private corporations (otherwise referred to as Canadian small businesses). During the consultation period, which ended on October 2, 2017, the public was given the opportunity to comment on the proposed changes. The Government received an astounding 21,000 submissions during this period. Further changes to the proposals were announced in October 2017 (see below) through to the Fall Economic Statement released on October 24, 2017. Below is an updated summary of the proposals.
July 18, 2017: Initial proposals
The initial proposals were outlined in the July 18, 2017 consultation paper and draft legislation. The changes were targeted to the following tax-planning strategies employed through Canadian small businesses:
- Income sprinkling: Measures were proposed to expand the scope of the existing “kiddie tax” regime to adults so that dividends received by adult family members will be subject to a reasonableness test. Dividends received that are above the “reasonable” amount would be subject to top marginal tax rates and would have no access to personal tax credits.
- Lifetime capital gains exemption (LCGE): A proposal was made to restrict the ability to multiply the LCGE for minor children through the use of a family trust and for individuals who do not meet the reasonableness test (as per the income sprinkling measure above) in terms of contributions to the business.
- Passive investments: A proposal was made to eliminate the advantage enjoyed by corporations which have a larger capital base available for passive investments. The advantage is due to the large differential in the taxation of a corporation’s active business income and the personal tax rate on those same earnings when earned by a salaried individual. The proposal sought to impose alternative methods for determining the tax treatment of income realized on a passive investment portfolio and to eliminate the refundable tax regime and the ability to pay tax-free capital dividends from the un-taxed half of capital gains.
- Converting income into capital gains: Measures were proposed to strengthen the anti-avoidance rule aimed at preventing surplus corporate income from being converted into capital gains, a process known as “surplus stripping”.
A more detailed explanation was issued by our Tax & Estate InfoService, titled Tax planning using private corporations – significant changes proposed. .
We also issued a follow-up piece on the proposed passive investment income changes, titled Corporate investment accounts – Going, going gone .
October 16-19, 2017: Amended proposals
On October 16, 2017, the government announced:
- It will proceed with the income sprinkling measures as planned
- It will not move forward with the proposed changes to the LCGE
- It intends to lower the small business tax rate on active business income (ABI) from 10.5% to 10% effective January 1, 2018, and further reduce the rate to 9% effective January 1, 2019;
- This will reduce the non-eligible dividend gross-up rate to 16% effective January 1, 2018 and 15% effective January 1, 2019. The corresponding non-eligible dividend tax credit will also change to 8/11 and 9/13 of the gross-up value for 2018 and 2019, respectively.
- Approaches on limiting tax planning using private corporations would be amended to better target the relatively small number of high-income individuals that utilize existing tax rules to gain personal tax advantages; and
- Amendments made to the income sprinkling tax rules are only intended to target private corporation owners who lower their personal income taxes by sprinkling income to non-contributing family members (businesses with contributing family members would not be impacted)
On October 18, 2017, Federal Finance Minister Bill Morneau outlined the Government’s measures to limit tax deferral opportunities on passive investments held by private corporations, while also providing the following flexibility to business owners:
- Grandfathering of all past (existing) investments and income earned from those investments;
- A $50,000 threshold would be set for annual passive investment income earned in a Canadian small business, before it would be affected by the new rules. As an example, assuming a nominal rate of return of 5%, this would permit $1 million in savings to be exempt from the new punitive tax regime. The Finance Minister indicated that, in light of the adjustment that would allow $50,000 of passive investment income to be sheltered annually, only 3% of Canadian small business corporations in Canada will be affected by the new rules. The adjustment allows business owners to save for personal retirement and business contingencies; and
- Incentives will be introduced to encourage investment in innovation by venture capital and angel investors.
And on October 19, 2017, the Government announced that, to avoid unintended consequences, it would not be moving forward with measures relating to the conversion of income into capital gains (surplus stripping).
Fall Economic Statement
On October 24, 2017, the Finance Minister delivered the Government’s Fall Economic Statement (FES). In his statement, the he reaffirmed his department’s commitment to the revisions outlined on October 19. As well, additional changes were proposed, namely:
- Canada Child Benefit (CCB): The indexation of the CCB to cost of living increases, beginning July 2018. This was originally announced in the fall of 2016, but the timeline for rolling out this change has now been shortened by two years.
- Working Income Tax Benefit (WITB): Beginning in 2019, the maximum benefit receivable under the WITB will be increased for eligible individuals. Also, the income range to qualify for the WITB will be expanded, extending eligibility to a greater number of workers. Further details on changes to the WITB will be announced in Federal Budget 2018.
Further details on these proposed changes are available on the Department of Finance website: