By Ron Walsh and Kevin Walsh.
For private corporations across the country, the past week was a suspenseful one as the federal government rolled out a series of announcements about its proposed tax changes. In case you missed them, here’s a play-by-play—and our reaction to the news.
Ottawa’s move: Proposed limit on income sprinkling will take effect on January 1, 2018.
The Finance Department’s original July 18 proposals broadened “tax on split income” rules to cover spouses and adult children. The plan: tax dividends paid to these individuals at the highest personal rates, barring proof that the dividends were reasonable based on contributions to the business. The criteria for the so-called reasonableness test:
• Labour contributions;
• Capital or equity contributions;
• Assumption of financial risk; and
• Past contributions of labour, capital or risks.
The government faced much criticism for the complexity and ambiguity of this test. Also, documenting the contributions of spouses and adult children would require taxpayers to perform detailed and complex analysis before distributing dividends.
In response to an overwhelming public outcry, Ottawa plans to release revised draft legislative proposals. These will aim to reduce the complexity of the rules and related compliance burden for documenting family members’ contributions when applying a reasonableness test.
Walsh King’s view: Until we see the revised legislation, we can’t comment on whether it will improve this proposed change to the Income Tax Act.
Lifetime capital gains exemption
Ottawa’s move: No restricted access to the lifetime capital gains exemption.
Walsh King’s view: We were pleased to hear this news.
Small business income tax rate
Ottawa’s move: Reinstate the small business tax rate reductions cancelled in the 2016 budget. The rate will decrease from 10.5% to 10% on January 1, 2018, and to 9% on January 1, 2019.
Walsh King’s view: Walsh King believes Ottawa made this announcement for political purposes, to manage taxpayers’ negative reaction to the July 18 proposals. Although business owners always welcome tax reductions, we’re not sure how this announcement ties into an overarching tax strategy to help the middle class and grow the economy. We encourage Ottawa to approach any changes to the Income Tax Act with those two goals in mind—rather than punish a select group of taxpayers.
Tax on passive investment income
Ottawa’s move: This proposal is a go, but the increased tax will not apply to passive investment income under a $50,000 annual threshold. The Finance Department also confirmed that past investments and income earned from those investments will be protected.
How did we get here? In its July 18 proposals, the government said it would look at drafting legislation to eliminate the tax advantage that lets private corporations invest after-tax income inside the business. Its stated goal: to ensure that a business owner would have no more ability to accumulate investment assets than an individual earning employment income.
Walsh King’s view: Many tax professionals and firms, including ours, made submissions to the government noting that business owners have very different financial exposure than employed individuals. Chiefly, they take on substantial personal risk to create a business and generate employment and do not receive employer-paid benefits, pension entitlements and severance if their company downsizes.
We still disagree with the government’s approach to taxing passive investments in a private corporation. Companies often require a slush fund to offset business cycles and economic downturns, and to fund acquisitions of equipment or other capital improvements.
Ottawa’s move: Scrap rules proposed on July 18 covering the conversion income to capital gains.
Walsh King’s view: Good riddance. These proposals had many far-reaching and unintended consequences, especially when it comes to estate planning, intergenerational transfers of farms and other businesses, and capital dividends.
Of all the proposed changes, these concerned us the most. However, the government did say that it’s looking “to develop proposals to better accommodate intergenerational transfers of businesses while protecting the fairness of the tax system.”
Posted in Tax Legislation
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