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New Tax Measures for Private Companies
The Federal government recently released its proposals affecting the taxation of private companies which will be effective for the 2018 taxation year. These changes were forecast in the 2017 Federal budget released in March, and will have a significant impact on tax planning for many of our firm's clients.
There are three proposals we want to highlight for you:
1. The government proposes to introduce a reasonableness test for income-splitting through dividends paid to an adult family member. Currently taxpayers earning active business income through private corporations have been able to "sprinkle" dividends to adult family members not actively involved in the business, to take advantage of their low tax brackets and/or tax credits. With the introduction of a reasonableness test, where dividends are found to be unreasonable with regard to the family member's labour and capital contributions, their dividends will be subject to the top personal marginal tax rate under the tax on split income ("TOSI") provisions of the Income Tax Act.
2. Active business income earned by a private company is subject to corporate tax rates which are lower than the top personal tax rates. Accordingly there is a tax benefit (i.e a tax deferral) to retaining business income within a private company to make passive investments. For instance, if a high-income shareholder were to take an additional salary of $100,000, they would be left with less than $50,000 after personal income taxes to make a passive investment; whereas retaining the income in the private company would leave $85,000 (after paying corporate taxes at a 15% small business tax rate) to make passive investments. The Federal government proposes to eliminate the tax deferral on business income that is retained to make passive investments. The government is considering different alternatives before issuing draft legislation. One alternative being considered is the introduction of a special refundable tax that will likely raise the corporate tax rate to approximately the top personal marginal tax rate.
3. Accrued gains on private company shares while held by a family trust as well as for shares held by individuals whose dividend income therefrom would be subject to the tax on split income will cease to be eligible for the lifetime capital gains exemption. Also, individuals under the age of 18 will no longer be able to claim the lifetime capital gains exemption.
The new proposals will be subject to a consultation period of 75 days and final legislation is expected to be released before the end of 2017.
We will keep you informed when the final legislation is released.