The Liberal Private Corporation Tax Proposals: An Update

Our previous article discussed the new tax proposals issued by Finance Minister Morneau on July 18, 2017. These tax proposals were hinted at during the Liberal party election platform as well as the 2017 Federal budget with the messages of tax fairness for the middle class and closing unfair tax loopholes often used by wealthy Canadians.  The tax proposals that were announced in respect of these main issues focused on three areas: income splitting using private corporations, passive investment income from holding investments in private corporations and the conversion of dividend income into capital gains to achieve a lower tax rate, known as capital gain stripping. 

The proposals included a 75 day consultation period ending October 2nd which allowed for those interested to submit comments regarding the proposals and draft tax legislation that was introduced.  After an overwhelming response of more than 20,000 submissions and much negative press the proposals have been significantly amended. While it appeared that the Liberals were going to stand tough behind their proposals, they ended up backing off on most of them though they may come back in the future in an altered manner.

So what do we know at this point?

The proposals that targeted the capital gains stripping have been completely rescinded. Many business owners, especially farmers and fishers, commented that these provisions would severely limit their ability to plan for business succession to family members.  These proposals also negatively affected the potential for estate tax planning where there could be double taxation issues.

The proposals which targeted the passive income issues did not include any draft legislation but provided a detailed commentary of what was targeted. The main issue was the ability to reinvest excess funds earned by a private corporation in an investment portfolio that would have been subject to a lower tax rate than if the funds have been available to an individual.  This would have created an unfair advantage for the owner of an incorporated small business versus being an employee.  However, Finance failed to recognize that small business owners don’t have the ability to rely on steady employment income and company pension plans and may rely on investments for business contingency and their own retirement planning.  After it appeared that the proposals were going to repeal the refundable tax system that is in place for investment income there have now been some concessions.  The main one being that currently existing investment portfolios and income derived from them will be grandfathered from the new tax rules.  Any new investment income will be subject to the new tax rules but the first $50,000 of investment income each year will be taxed under the old rules.  This sounds like some complex tracking of investment pools and income will be required in the future that will be time consuming for business owners and their accountants.     

The income splitting proposals that were introduced as draft legislation have largely been left intact with the exception of limiting the access to the Lifetime Capital Gains Exemption. Therefore, the ability to pay dividends to family members will be significantly limited and will be subject to a reasonability test based on the age of the family member.  The ability to define reasonable will be very difficult and highly subjective.  This will be a major issue when it comes to a CRA audit for sure. 

Finally, Finance announced that the federal small business tax rate is being reduced from 10.5% to 9% over the next two years. So after they have targeted small businesses with the unpopular proposals they have seemly gone the opposite way with a tax rate break.  The whole scenario seems very piece meal and leaves one feeling unsure of the overall consequences of these tax decisions. 

Overall, while the most offensive tax proposals have been withdrawn or modified but there is no improvement noted in the absolute increased complexity that has been added to the taxation of private corporations. From tracking investment income pools to determining what is reasonable to pay a family member income from the business, small business owners will have an additional burden with respect to corporate taxation.  And there are still more questions than answers, since the draft legislation is still draft, and additional legislation is expected to be introduced but not likely until the 2018 Federal Budget. 

If your small business or private corporation is affected by these new tax changes, we at Jones & O’Connell LLP are available to help guide you through the uncertain future.  

The information presented is only of a general nature, may omit many details and special rules, is current only as of its published date, and accordingly cannot be regarded as legal or tax advice. Please contact our office for more information on this subject and how it pertains to your specific tax or financial situation.

Posted: Monday, October 16th, 2017 | Categories: Commentary.

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