Important Tax Changes for Canadian Private Corporations
JULY 27, 2017
On July 18, 2017 the Department of Finance released the whitepaper blue printing their proposed changes to current tax law, targeting what they perceive to be abuses by private Canadian corporations. These changes, if enacted, could have significant consequences on the current tax planning utilized by many private corporations across Canada. The Department of Finance is currently focusing on three main areas of tax planning in relation to private corporations:
Current tax law allows for payment of dividends from a private corporation to all shareholders over the age of 18 without consequence. Dividends of this nature are often used to shift income from a primary shareholder to a spouse or adult children (who are also shareholders), effectively reducing the overall personal tax paid on that money removed from the company.
The Department of Finance is looking to eliminate this income sprinkling technique by scrutinizing all dividends paid to shareholders who are related to the primary shareholder (who exercises influence over the corporation). For example, if dividends paid to these related shareholders are deemed to be unreasonable (based on factors such as their involvement in the company, capital contributions, risk etc.) the recipients will pay high rate tax on those dividends.
The income sprinkling changes above will not only affect corporations but distributions from trusts and partnerships as well.
Furthermore, the Department of Finance is looking to curb the use of the lifetime capital gains exemption. Proposed changes include completely disallowing the exemption for taxpayers under the age of 18. For taxpayers who are 18 or older, the exemption will be allowed based on a reasonability test (this test will be more stringent for recipients between the ages of 18-24). Finally, any appreciation on shares while held in a trust will not be eligible for the exemption. These proposed changes are targeted to be effective in 2018.
The next issue targeted by the Department of Finance involves active corporations holding passive investments. Currently Canadian corporations enjoy preferential tax treatment on income earned in an active business which leads to a significant deferral of income tax on active income that is left in the corporation. It is the Department of Finance’s view that this deferral of income tax should not extend to active income left in the corporation that is subsequently invested in passive assets (stocks, bonds, rentals property, etc.…).
Current proposals include a higher tax on passive income or potentially a tax on the passive assets themselves, designed to promote fairness by fully equating the tax consequences of investing in passive investments within a corporation to those of an investor investing in the same assets outside of a corporation. A timeline for enactment of these changes has not yet been provided.
Conversion of Dividend Income to Capital Gains
Finally, current tax law contains provisions that place restrictions on the ability of a shareholder to use multiple corporations to extract money from one corporation in the form a capital gain when it would otherwise be taxed as a dividend. Such planning can provide a significant advantage to shareholders as currently capital gains are taxed at preferential rates in Canada. The Department of Finance has outlined changes to add further exceptions to the existing provisions of the Income Tax Act further restricting a shareholder’s ability to engage in this type of planning. This legislation is effective immediately.
The Department of Finance is currently taking feedback on these proposals with the consultation period being open until October 2, 2017. Fort Group Chartered Professional Accountants is currently monitoring these proposed changes in relation to all of our clients. As always, we will continue to analyze the impact of these and all other changes to our current tax environment as they relate to each client we service, updating each client’s tax plan as necessary.
If you have any questions about these changes and how they affect your business please feel free to contact one of our advisors.