Canadian Tax and Estate Planning

During the past week or so, the Federal Government announced a decrease to the small business corporate tax rate, and has also issued several press releases announcing changes to its tax proposals using private corporations. These press releases relate to tax planning proposals that were originally released on July 18, 2017 (click here for a summary of the initial proposals).

In the Fall Economic Statement on October 24, 2017, the Federal Government confirmed that it was not going to move forward with the proposed changes to multiplying the Capital Gains Exemption or to Converting Income to Capital Gains. They also confirmed that they would move forward with the proposed changes to income splitting and investing in passive assets, with some modifications. While we were hoping for more details regarding the changes that they will be moving forward with, few details have yet to be communicated, and we will have to wait for the actual legislation to be released at a later date to fully understand the impact of these new rules.

Multiplying the Capital Gains Exemption – no longer moving forward

Many private corporations have structures in place that will allow for multiple family members to use their Capital Gains Exemption on the sale of their corporation. This is an effective way to reduce the overall family’s capital gains tax when the company is sold. The initial proposals were going to reduce or eliminate the effectiveness of this planning in many cases. The government will no longer be making any changes to the existing rules and this type of planning will continue to be available.

Converting Income to Capital Gains – no longer moving forward

The initial proposals were meant to eliminate tax planning that allowed an individual shareholder to distribute retained earnings of their company and pay the lower capital gains tax rates, rather than dividend tax rates. The initial proposals were complex and had many unintended tax consequences. The government will no longer be making changes to these rules and, as a result, this type of planning will continue to be available.

Income Splitting – moving forward

The government is moving forward with the proposed changes to income splitting, with some modifications. The initial proposals introduced a reasonableness test for any dividends paid to family members. The problem was that there were no rules or guidance outlining what was considered reasonable. It was clear that if a family member did not contribute to the business, then any dividends received by them would be unreasonable and taxed at the highest tax rate. The confusion was in determining a reasonable dividend to pay family members who did contribute to the business. The government announced that it will simplify the reasonableness test and issue revised draft legislation some time this Fall. We will not fully understand these rules until the draft legislation is made available. What we do know is that the new rules will be effective January 1, 2018, so the current rules will continue to apply for the remainder of the year. As a result, income splitting should be maximized where possible in 2017.

Investing in Passive Investment – moving forward

The government is moving forward with the proposed changes to investing in passive investments, with some modifications. It was unclear if the initial proposals would apply to existing investments and any new investments would have to be caught under the initial proposals once they were enacted.

The government has confirmed that the new rules will not impact existing investments or the future income on those investments. In addition, the first $50,000 of investment income earned will continue to be taxed under the current tax rules. So, the new proposals will only apply to investment income over $50,000 in a year.

At this point there is no draft legislation, so we do not know the effective date of these rules or how they will ensure that prior investments and income on such investments will not be subject to the new rules. The government announced that draft legislation will be issued in the 2018 Federal Budget, so we will have to wait until then to get more clarity. At this point, there is no reason not to continue investing in passive investments inside your corporation.

Changes to Small Business Tax Rates and Non-Eligible Dividends Tax Rate

These changes were not part of the initial proposals released on July 18, 2017. The federal small business tax rate will decrease from 10.5% to 10% as of January 1, 2018 and to 9% as of January 1, 2019. The personal tax rate on Non-Eligible Dividends will increase to reflect the lower small business tax rate. The top federal tax rate on Non-Eligible dividends will increase from 26.3% to 26.65% in 2018, and 27.56% for 2019 and future years.

While these changes are welcome news, there still remain many unanswered questions regarding how the new rules for income splitting and investing in passive assets will work, and we will have to wait until draft legislation is issued before we can fully understand them.

In the meantime, please contact your Fuller Landau advisor to discuss how these proposed changes may impact you, your family, and your business. If you’re new to Fuller Landau, partner Gord Jessup, head of our Tax department, would be happy to help.