Important Changes Proposed To Corporate Tax Planning And Tax Reduction Strategies

Here’s what you need to know about the proposed tax changes announced last week.

On Tuesday July 18th, Finance Minister Bill Morneau announced proposed tax changes that could have an impact on many Rise CPA clients. The changes are meant to close perceived gaps in the legislation that allow business owners to reduce their overall tax burden. These are broad, far-reaching changes to the tax legislation that seek to change long-standing provisions that are in the tax legislation to support and encourage businesses.

In Budget 2017, the government said they would address tax planning strategies using private corporations and last Tuesday’s announcement comes with the release of the paper outlining their conclusions and next steps.  The paper specifies three specific areas of tax planning:

  1. Sprinkling income using private corporations, which can reduce income taxes by causing income that would otherwise be realized by a high-income individual facing a higher personal income tax rate to instead be realized (e.g., via dividends or capital gains) by family members who are subject to lower personal tax rates or who may not be taxable at all.

The proposed changes will bring significant uncertainty to closely held and family run businesses. While the “kiddie tax” currently applies to minors under the age of 18, the new rules propose to further introduce a form of reasonableness test (based on services provided to the business, capital contributions, etc.) for individuals over the age of 18. This new reasonableness test will be stricter for individuals between the ages of 18 and 24.

In addition, the proposed changes will impact the ability to claim individual lifetime capital gains exemption in many common trust structures that business owners have in place. There is some small comfort in that they are proposing a transitional period up until the end of 2018 for business owners to take steps to mitigate the overall impact. Some of these steps may have to be taken by the end of 2017 to be effective.

  1. Holding a passive investment portfolio inside a private corporation, which may be financially advantageous for owners of private corporations compared to other investors. This is mainly due to the fact that corporate income tax rates, which are generally much lower than personal rates, facilitate the accumulation of earnings that can be invested in a passive portfolio.

No draft legislation was provided on this piece but the consultation paper does outline the government’s intention to ensure that companies do not have the ability to use the corporate tax deferral for non-active investments. Finance has asked for feedback on several questions in relation to this piece and have stated that any changes will only be effective on a go-forward basis after draft legislation is actually produced.

  1. Converting a private corporation’s regular income into capital gains, which can reduce income taxes by taking advantage of the lower tax rates on capital gains. Income is normally paid out of a private corporation in the form of salary or dividends to the principals, who are taxed at the recipient’s personal income tax rate (subject to a tax credit for dividends reflecting the corporate tax presumed to have been paid). In contrast, only one-half of capital gains are included in income, resulting in a significantly lower tax rate on income that is converted from dividends to capital gains.

The Canada Revenue Agency has long held the view that “capital gains stripping” was not allowed under the current legislation (although they had no problem with it in the context of post-mortem situations). This view was not always shared by the courts. The new proposed legislation basically ensures that any distribution from a corporation must occur at the higher dividend rates. The way currently drafted, this would also eliminate certain post-mortem planning strategies used to eliminate the double-tax problem when an individual dies.

Who could be impacted by these proposed measures?

  • Any client who has a company set up with a trust as a shareholder
  • Any client who has a company set up with a family member as a shareholder
  • Any business owner who is holding, or looking to hold, passive investments within a company

When will these proposed changes come into effect?

Rules around sprinkling income using private corporations will come into effect on January 1, 2018 (that is, there will be no impact for any planning in place for the 2017 year). As noted above, there is to be a transitional period to the end of 2018 to mitigate the lifetime capital gains exemption impact.  The changes regarding converting a private corporation’s regular income into capital gains came into effect on July 18th, 2017. The other proposed measure regarding holding a passive investment portfolio inside a private corporation will undergo a 75 day consultation period and will only be effective once proposed legislation is introduced.

What does this mean for Rise CPA Clients?

While our tax experts are still looking at the finer details of these proposed measures, every client with a private corporation will need to review their structure to determine how the proposed changes could impact them and what steps may have to be taken to mitigate that impact. We will be scheduling meetings with all of our clients who may be impacted by these proposed changes in the course of the next few months to come up with an individualized plan to address these changes. 

If you have any questions, please feel free to call us at 604-936-4377.


More Reading

Tax Planning Using Private Corporations – Department of Finance Canada

Ottawa moves to end tax loophole favoured by rich professionals – Financial Post

Proposed income-splitting rules could land outsized hit on small businesses – The Globe and Mail