Our Response to the Trudeau Government’s Proposed Tax Changes
By: Talbot & Associates, Chartered Professional Accountants (September 18, 2017)
This is our response to the Trudeau Government’s Proposed Tax Changes: Talbot & Associates Letter to the Honourable William F. Morneau
On July 18, 2017, Finance Minister Bill Morneau released a consultation paper entitled “Tax Planning Using Private Corporations”. This is a document outlining proposed changes to our tax system, with an open invitation for feedback and suggestions until October 2, 2017.
Given these changes will affect many of our clients, as well as other business owners across Canada, we have decided to share a brief recap of, and our official response to the government’s proposals. Please find below a summary of the most significant changes that were suggested in the July 18 document:
Many Canadian business owners structure their affairs in a way that facilitates income splitting with their spouses and adult children. These may involve family trusts or different corporate structures to accomplish the goal of accessing lower tax rates available to those individuals (draft legislation has been created and presented on this issue and would apply to transactions occurring after December 31, 2017).
a. Extending tax on split income (TOSI) rules:
Typically, the TOSI rules affected “specified individuals” under the age of 18 and increased the taxes on any split income they received. The new rules would extend the definition of “specified individuals” to include Canadian resident individuals, whether minor or adult, who receive split income. They propose to introduce a reasonableness test for any amount of split income received – which may consider the individual’s labour or capital contributions to the business, as well as previous remuneration paid or payable in respect of the business. If this income is ruled to be unreasonable by CRA, the entire amount would be subject to the highest tax rate for individuals.
b. Constraining multiplication of claims to the lifetime capital gains exemption (LCGE):
Through certain structures, there was a capability of multiplying the LCGE to several family members on sale of qualifying assets. The proposed rules will no longer allow the LCGE to be claimed in respect of capital gains that are realized, or that accrue, before the taxation year in which the individual attains the age of 18. They would include a reasonableness test that is similar to those added to the TOSI above, and Discretionary Family Trusts would no longer permit individuals to claim the LCGE in respect of capital gains that accrue during a period in which a trust holds the property. As it relates to trusts, these rules hold true regardless of whether the beneficiary of said capital gain was actively involved in the business.
c. Supporting measures to improve the integrity of the tax system:
There may be additional reporting requirements to a trust’s tax account number; this will ensure trusts are subject to information reporting rules that are in line with corporations and partnerships.
HOLDING PASSIVE INVESTMENTS INSIDE A PRIVATE CORPORATION
Active income earned in a corporation tends to be taxed very favourably – the goal is to provide more opportunities for businesses to re-invest in their business and to create more jobs for the economy. By virtue of paying a lesser tax rate, certain corporations may be left with additional funds they do not require for active business, nor have they withdrawn the funds personally. Due to the fact they’ve only paid the low corporate tax rate on the active income, they may be left with a larger pot of capital to inject to passive investments (currently no draft legislation has been presented on this issue and therefore no timeline for implementation).
a. Apportionment method:
This would involve further tracking of the source of income used to acquire each investment asset owned by a corporation, along with the investment income that the asset generates. Although passive income is taxed at the highest rate within a corporation currently, some of it is refunded through the Refundable Dividend Tax on hand (RDTOH) account when allocated to shareholders. Under the proposed system, the additional taxes payable cease to be refundable.
b. Elective method:
Private corporations would be subject to a default tax treatment, unless they elect otherwise. The election changes depending on the type of income that corporation is earning, whether mostly at the general rate or otherwise. The end result changes the type and amount of “eligible” or “non-eligible” dividends to be paid out. The most significant change is again to the RDTOH which ceases to be refundable.
It is important to note, that under both methods, taxation on this income ends up being more than the highest personal rate. In many scenarios, the tax rate can exceed 70% once withdrawn from the corporation.
CONVERTING INCOME INTO CAPITAL GAINS
In most cases, shareholders of private corporations are compensated by way of a salary, by dividends, or some combination of the two. In the past, individual shareholders, through specific internal transactions, have been able to convert corporate surplus that should have been taxable as dividends, or salary, into lower-taxed capital gains (draft legislation has been created and presented on this issue and would apply to any transactions that happen after July 17, 2017).
a. Section 84.1 of the Income Tax Act be amended to prevent individual taxpayers from using non-arm’s length transactions that allow this sort of surplus stripping.
b. Adding specific anti-stripping rule to counter tax planning that circumvents tax law meant to prevent the conversion of a private corporation’s surplus into tax-exempt, or lower-taxed capital gains.
We strongly recommend that if you agree with us to share your concerns about these proposed tax changes by contacting:
- Your local MP
- The Minister of Finance, by emailing: firstname.lastname@example.org
STAY INFORMED: Talbot & Associates will provide regular commentary as developments related to the proposed tax changes occur in the coming weeks and thereafter. In order to comply with Canadian Anti-Spam Legislation, if you currently are not receiving our digital communication featuring announcements, updates and notifications of seminars etc., we encourage you to email us at email@example.com and let us know you’d like to be put on our e-communications distribution list.