Department of Finance Update - Tax Planning Using Private Corporations

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Update: Department of Finance Release December 13, 2017.

It’s been a long few months in the tax world, as we eagerly await the release of the promised draft legislation ahead of the January 1, 2018 implementation from the Department of Finance ("Finance").  As promised, the government did release the draft legislation “later this fall”, with just a few short days before the seasons officially change to winter and the holidays kick off (hoping the vast majority of the population forgets about it).

Here’s an update of what you need to know, given the new and improved draft legislation:

Income sprinkling

This is the largest and most complex change that came from their release.

A History

Previously, small businesses were able to pay dividends to shareholders, regardless of their contributions to the business. As Canada’s tax system focuses on the individual, rather than the family unit, the result is an individual earning $150,000 will pay more tax than two spouses earning $75,000 each.

Income splitting is a common practice for incorporated small businesses, allowing family members to subscribe for common shares, and for them to receive income either directly or indirectly (such as through a Trust). Previously, no reasonability measures were in place, as it was assumed that the family unit contributed to the success of the business overall.

Changes

Going forward, there will be a reasonable test that must be met in order to receive dividends from a small business. If the reasonability tests are not met, TOSI (tax on split income) rules will apply.

The government has proposed that a contribution to the business can be defined as:

  1. Works more than 20 hours per week in the current year (pro-rated for seasonal operations) or

  2. Has previously met the above test for at least five years

The government has also proposed that if the individual is:

  1. At least 20 years old by the end of the year AND

  2. Owns 10 percent of the business,

AND

  1. The Company earns less than 90 percent of its income from services and,

  2. Is not a professional corporation.

Conclusion

The new proposed changes are increasingly complex regarding income splitting, with a great degree of variability in the word “reasonable”. Ensure that you are working with your advisor on these proposed changes.


Trusts and the Capital Gains Deduction

Finance has confirmed that they will abandon the tightening of rules for the use of the lifetime capital gains exemption and the multiplication of the lifetime capital gains exemption through vehicles such as a Trust.  Good news if you plan to sell a business!

Passive Income

Finance has confirmed that this will be released with the 2018 budget and provided no further updates

Converting of income to capital gains

Finance has confirmed that they will not proceed with this proposed change.

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