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Posted by Tax Consultants

2017 Tax Changes

Announced on July 18, 2017

The Canadian federal Finance Minister, Bill Morneau,  the release of a consultation paper and with a draft legislation which, will have a dramatic impact on the taxation of Canadian private corporations and business structures that Canadian entrepreneurs have had in place for decades if enacted.

The government’s proposals which target (1) income splitting strategies, (2) access to the lifetime capital gains exemption, (3) the tax treatment of passive investment income earned in a private corporation and (4) strategies to convert income into capital gains.

Income splitting

It is common for entrepreneurs who control private Canadian corporations to make use of ownership structures involving multiple family members. This can be achieved by either having family members hold corporation shares directly or through a family trust. Under these structures, family members (or the family trust) often hold different classes of shares which allow for dividends to be paid to the different family members at the discretion of the corporation’s directors or the family trust’s trustees. This share structure permits dividends to be paid to family members who are in a lower tax bracket than the family member who controls the business. This is referred to as “income splitting” or “dividend sprinkling” in order to reduce the overall tax burden of the family.

The proposals to address income splitting strategies with private corporations also expand the application of the TOSI to include (1) income from certain debt obligations, (2) capital gains from the sale of shares the income from which is subject to the TOSI and (3) compound income on property that is the proceeds from income previously subject to the TOSI rules or the income attribution rules. However, this third type of income will only apply to individuals under the age of 25.

The new anti-income splitting rules are to be effective starting in 2018.

Lifetime capital gains exemption

Since 1988, Canadians have been able to shelter capital gains from the disposition of “qualified small business corporation” shares from tax up to a lifetime limit. The government has identified concerns with common ownership structures that allow multiple family members to make use of their capital gains exemption on the sale a of a family-owned business. Under the proposals, the capital gains exemption will be denied in the following circumstances:

  1. individuals under the age of 18 will not be allowed to make use of the capital gains exemption;
  2. beneficiaries of trusts will no longer be permitted to make use of the capital gains exemption with respect to gains on the value of shares that accrue during the period in which the trust holds the shares; and
  3. individuals who are subject to the TOSI with respect to a share will not be able to make use of the capital gains exemption on the sale of such shares.

These new rules are to be effective starting in 2018. However, the proposals include a transitional rule that will allow an election to be made by the end of 2018 to crystallize a capital gain and claim the capital gains exemption so as to increase the adjusted cost base of the “qualified small business corporation” shares. Making such an election will reduce the individual’s capital gain on a subsequent sale of the shares.

Passive investment income

The consultation paper identifies a concern with respect to a potential advantage that arises from earning business income through a corporation rather than individually. Corporations are taxed at a much lower rate than individuals on business income. As a result, more after-tax dollars are available for investment if earned through and retained in a corporation. This is an intentional tax policy decision to encourage reinvestment of business profits to broaden the tax base and increase employment. However, the government has expressed concern that this fact of the Canadian corporate tax system is unfair if the surplus funds are used for passive investment rather than reinvestment in the business.

 Converting income into capital gains

Intended to allow a shareholder to extract retained earnings from a private corporation as a capital gain rather than as a dividend. This is beneficial to the shareholder, as capital gains are taxed at a lower rate than dividends. Amendments are proposed to the anti-surplus stripping rule in section 84.1 of the Income Tax Act to shut down this type of planning. These changes would apply on or after July 18, 2017.

2016

The federal government is ending four child tax credits this year: arts, fitness, education and textbooks in 2017. Parents of children under the age of 16 can pre-pay 2017 arts and fitness programs to claim them on 2016 tax returns as long as total spending for 2016 does not exceed $250 and $500 limits, respectively

It is also cancelling income splitting for families, a tax reduction measure that allowed someone to transfer up to $50,000 of income to a spouse with lower income if they had a child under 18 years of age. The tax credit for income splitting was capped at $2,000.

Offsetting those changes are the Canada Child Benefit and changes to Employment Insurance benefits introduced in 2016.

“High income earners in most provinces will pay more but for the majority of Canadians, these two changes will mean more money in their pockets.

Several other changes at the federal level will affect life insurance, business owners selling their companies and some mutual funds.

 Business owners, large and small, will gain less from the sale of their operations as assets such as goodwill and trademarks will become fully taxable as investment income. Currently, half of the proceeds can be distributed tax-free as a dividend.

Investors will also no longer be able to rebalance their non-registered mutual fund investments in corporations structured as “switch funds” on a tax-deferred basis. As of the new year, capital gains from such moves will be taxed in the same way as equities

 Finally, various tax amounts — including maximum RRSP contributions, tax brackets and maximum amounts of various credits — will increase in 2017 to reflect inflation but the tax-free savings account limit remains at $5,500.

2014 and 2015

Higher Taxes in BC – The province has introduced a new temporary tax bracket on income over $150,000 or higher in 2014 and 2015.  The provincial tax rate on this income will climb from 14.7% to 16.8% meaning that all income above 150K will be taxed at a new and higher combined provincial and federal tax rate of 45.8% (currently 43.7%).  mk apples2mk 5

 

Dividends vs. Salary for Business Owners – Effective Jan 1, 2014, business owners benefitting from the small business deduction will lose the benefit of choosing dividends over salary income.  As there has been a 2%-3% tax advantage in electing dividends vs. salary payments, the 2013 Federal Budget introduced this change in order to improve the tax integration rules.  With the change, business owners will pay the same rate of tax regardless of which option is chosen.

 

Safety Deposit Boxes – The cost of renting a safety deposit box from your corner bank will no longer be a permitted deduction.  The rationale here is that more Canadians are storing personal items such as jewelry in the boxes rather than share certificates.

 

Lifetime Capital Gains Exemption – the exemption rate has climbed from 750K to 800K.  Owners of CCPCs (Canadian Controlled Private Corporations) will be exempt from paying tax on up to 800K of any realized capital gain from the sale of their business.  Certain rules apply.  If you’re interested in finding out how you can multiply the capital gains exemption with family members with the use of a family trust, drop me a line.

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Children’s Tax Credits – there are a number of tax credits which parents can access but time is running out for 2013 if you haven’t incurred the expense already.  These include the Children’s Fitness Tax Credit, and the Children’s Art Tax Credit.

 

Charitable Donations – as with the above, qualified donations should be made by year end.  Here’s a quick tax planning tip: You can make a donation in kind, meaning you can donate stocks or mutual funds showing a capital gain.  No tax will be payable on the capital gain and the donor will receive a tax credit calculated on the full value of the donation.