Reading the Tax Tea Leaves

As we have previously discussed, significant tax proposals were released on July 18, 2017 that targeted three areas:

  1. Income sprinkling (including multiplication of the capital gains exemption)
  2. Converting income into capital gains
  3. Holding passive investments inside a private corporation

The first two items had detailed draft legislation with explanatory notes while the third item had a discussion paper with no detail on what changes were coming. These changes have been the subject of much discussion given the broad sweeping changes that were being proposed, the lack of true participation from all stakeholders and the short period of time in which comments could be made. The government accepted submissions on these proposals until October 2nd. According to the government, over 21,000 submissions were made.

Last week (only 2 weeks after the submission deadline) saw a number of announcements concerning the above proposals. These are summarized below along with our impressions on them.

Oct 16th announcement
The first announcement made concerned income splitting and the capital gains exemption. The sound bites from the government on this front are the new rules concerning income sprinkling will be simplified and that there are no changes to the lifetime capital gains exemption.

While revised detailed legislation is expected later this fall, we can make the following observations:

  1. While the government is stating the rules will be simplified, this will be more targeted to the interpretation and application of the new rules rather than providing any real changes to what has already been drafted. In essence, what has been drafted and the various tests outlined will more and likely remain.
  2. Notwithstanding the statement that no changes are being made to the lifetime capital gains exemption, we find it unlikely that the government will not propose some changes to limit a non-active shareholder, or someone under the age of 18, from utilizing their lifetime capital gains exemption. Whether this will be in the revised legislation released this fall or in the 2018 budget, we don’t know.
  3. Any changes will be effective January 1, 2018.

At the same time as the above changes were announced, the government announced that the small business tax rate (payable on the first $500,000 of taxable income) will be reduced to 10% effective January 1, 2018 and 9% effective January 1, 2019. While not announced, it is fully expected that the personal tax rate on dividends will be increased as well. In essence, if you pay out all the income from your company, this change will not impact you as the total taxes paid will be the same.
While this is good news for businesses, given the government’s comments that individuals are using corporations to lower their tax bill, it seems counterintuitive to further increase the gap between corporate income taxes and personal income taxes.

Oct 18th announcement
The second announcement dealt with holding passive investments inside a private corporation. It is the government’s intention to move forward with changes but only apply them to passive income in excess of $50,000. Detailed legislation is to be released with the 2018 budget.

Since the government hasn’t released any information concerning what they propose to do, there is now major uncertainty with many business owners. Questions we have surrounding any changes:

  1. When will the effective date of any changes be? January 1, 2018? Budget release date? January 1, 2019?
  2. The intention is that the changes will only be applied on a go forward basis. Will that include accrued but unrealized gains on capital property? Will this require a formal valuation of assets to substantiate values?
  3. What will happen to losses realized after or prior to the effective date? Will they be able to be carried back or forward to offset income realized under different rules?
  4. Will capital gains on property used in an active business be caught?
  5. How will “compound” income (that is, second and later generation income earned on the initial $50,000 income) be treated?

Unfortunately, the government has decided that business owners should wait until Budget 2018 to find out the true impact to these changes.

Oct 19th announcement
The final announcement made on Thursday related to converting income into capital gains. The main item here is the government’s statement that is will not be moving forward with these proposed changes. On the face of it, this announcement seems like good news especially given that these changes were to be effective July 18, 2017. Does this mean that all proposed changes to section 84.1 and new section 246.1 are now gone? As no details were released it is hard to be too pleased with this announcement and unfortunately, no true certainty can be had until at least Budget 2018 is released.

Final thoughts
These proposed tax changes are a major change to how the taxation of private companies occurs – rules that have been in place for over 30 years. To make these changes with, what appears to be, very little thought into the full and complete impact and the range of taxpayers impacted is very reckless. Even with the announcements this week, the tax system will be inevitably worse off and more complicated than prior to July 18, 2017.
Generally, with proposed changes there is detailed legislation with fully vetted explanatory notes so that tax professionals can fully understand and help explain and communicate the changes and impact to business owners. Unfortunately, we are now in a “wait and see” mode which creates uncertainty in what the tax landscape will come January 1, 2018.

While for greater tax certainty it may be best to close any sensitive transactions prior to Budget 2018 (for which there is no date set yet) or even by December 31, 2017, a full review of your particular situation is needed to ensure that the whole situation is considered and not just the tax aspect. If you have any questions about how these proposals could impact you and what options you may have, please give the team at Rise Advisors a call.