On July 18, 2017, Federal Finance Minister Bill Morneau released a consultation paper on proposed private corporation tax measures. These measures are designed to close tax advantages used by Canadians who use private corporations for income sprinkling, accumulating passive investment income and converting income into capital gains.
Most of the proposed changes are anticipated to be implemented on a go forward basis, effective for 2018. Many businesses will need to review their corporate and compensation structures and consider planning for changes to be in effect for 2018.
Which practices is the government focusing on?
1. Income-Splitting Using Private Corporations
Perceived Benefit: Shifting income that would otherwise be realized by a high-income individual to family members (usually a spouse) who are subject to lower personal tax rates (e.g., via dividends or multiplication of the lifetime capital gains exemption (LCGE)).
Proposed Measure: Extend the existing “tax on split income” rules that previously applied to minors (“kiddie tax”) to certain adult individuals. The change would effectively impose a tax at the top personal rate on dividends paid to any related individual who provide no labor or capital contributions to the business.
Reasonable payments made to related parties who do help in the business would not be affected by this change.
In addition, a related individual would no longer qualify for the LCGE in respect of capital gains that are realized, or that accrue, before the taxation year in which the individual attains the age of 18 years. Also, there will be restrictions on using the LCGE for gains accruing through family trusts.
2. Holding a Passive Investment Portfolio Inside a Private Corporation
Perceived Benefit: Corporate income tax rates, which are generally much lower than personal rates, may facilitate the accumulation of earnings that can be invested in a passive portfolio, providing the owner with a significant tax deferral advantage.
Proposed Measure: The government is considering changes such that investments held within corporations are taxed at the same effective rate as investments held directly. According to the government, the tax advantage conferred on private corporations – the lower rate of tax –was never intended to be used to realize higher personal savings.
What are the Next Steps?