By Paul Walker, Senior Manager, Tax at BDO Canada
Finance Minister Bill Morneau released the much anticipated consultation paper proposing changes to how private corporations are used to gain tax advantages. The government commenced consultation process that will close on October 2.
The proposed changes are far-reaching and will impact all Canadians who use private companies, including family businesses and incorporated professionals. Specifically these proposals can have a negative effect on the Tech Community by stifling family and friends funding, Angel funding and potentially VC funding. Individuals and businesses impacted by any of proposals should begin planning revised strategies as soon as possible.
Following is a summary of what the consultation paper contains.
The government is proposing to expand the tax on split income rules that are in place to curtail income splitting to now include any Canadian resident individual, regardless of age, who receives split income to the extent that the split income is determined to be unreasonable under certain criteria. Split income is taxed at the top marginal personal tax rates.
These proposals would be effective for 2018 and later tax years and may severely limit the ability of business owners to split income with family members.
Multiplication of the Capital Gains Exemption
A surprise in the document released by the federal government was the significant restrictions proposed for the use of the lifetime capital gains exemption (LCGE).
The policy paper proposes to significantly restrict the circumstances in which the LCGE may be claimed including elimination of the LCGE for individuals under the age of 18, restrictions for individuals where the capital gain is included in split income, and elimination of the LCGE which accrued within a trust (subject to certain exceptions).
These proposed rules will generally apply to dispositions occurring after 2017; however transitional rules are being proposed for certain dispositions that occur in 2018.
Holding passive investments inside a private corporation
The current system allows for a tax deferral of the individual tax payable if the shareholder leaves the funds in the corporation. The government believes that this tax deferral results in a significant tax advantage to owners of private corporations.
The suggested proposals would require taxpayers to identify the source of funds in the company that are being used to generate investment income, with the tax rate applied to this income being different depending on the source of funds. Additional non-refundable taxes on investment income would be used to eliminate the tax deferral advantage that accumulating investments in a corporation currently offers.
The paper is clear that the changes the government is considering should not apply to companies that reinvest the after-tax profits in the active business operations.
Converting income into capital gains
The third area addressed in the consultation paper deals with the manner in which shareholders of private corporations extract funds from their corporations. A significant tax benefit can be obtained by individual shareholders with higher incomes when planning is undertaken to convert corporate surplus that would normally be taxable as dividends or salary into lower-taxed capital gains. This is often referred to as surplus stripping.
The government is proposing two measures to prevent the surplus income of a private corporation from being converted to a capital gain and stripped from the corporation. The first is the expansion of an existing anti-avoidance rule regarding the non-arm’s length transfer of shares to a corporation and the second is the proposal of a new anti-avoidance rule aimed specifically at surplus stripping.
It is proposed that both of these measures will be effective as of the release date of July 18, 2017. This type of planning can no longer be implemented if these measures are enacted.
The government indicated it would consider whether there are features of the current income tax system that have an inappropriate and adverse impact on genuine business transactions involving family members.
BDO will be hosting 3 GTA breakfast seminars on “Attacking Private Corporations Tax Planning”
Are you a professional or business owner with a private corporation? Do you have a family trust? Are you unsure of what the recent Federal Government Consultation Paper covers? If so, join BDO across the GTA to discover the main areas of corporate tax planning that the Federal Government is attacking.
October 24th – Toronto – Design Exchange, 234 Bay Street
October 26th – Oakville – Oakville Conference and Banquet Centre, 2515 Wyecroft Rd
October 31st – Markham – Hilton Markham Suites Conference Centre, 8500 Warden Ave
8:00 AM – 8:30 AM I Breakfast & Registration
8:30 AM – 10:00 AM I Seminar