Tax Update #4
During the week of October 16, 2017, the federal government made several announcements regarding changes to the proposed tax measures originally released on July 18, 2017. Also announced, was a return to the planned reduction in the small business tax rate. While revised draft legislation has not yet been provided, the following is a summary of the changes as described by the Department of Finance:
Reduction in Small Business Tax Rate
The 2015 Federal Budget announced a phased in reduction of the small business tax rate to 9% by January 1, 2019. The 2016 Federal Budget subsequently suspended that reduction at 10.5%.
On October 16th, the federal government reinstated a small business tax rate reduction from 10.5% to 9% as follows:
- Effective January 1, 2018, the rate will drop to 10%; and
- Effective January 1, 2019, the rate will drop to 9%.
“Income Sprinkling” Within Private Corporations
The complex draft legislation released on July 18th proposed to significantly expand the rules that eliminate the tax benefit of splitting income amongst family members. The current rules apply only to minor children and the proposed rules would expand the application to certain adult family members. In addition, the type of income to which the rules would apply was also expanded, and a “reasonableness test” was introduced.
On October 16th, the federal government announced that these proposals would be revised:
- The measures will be simplified
- The government stated that family members making a “meaningful” contribution to a business will not be impacted – until revised draft legislation is released, we do not know how this will contrast with the original proposals
- A modified version of the draft legislation will be released this fall
Limitation of Lifetime Capital Gains Exemption
The draft legislation introduced on July 18th would significantly restrict the ability of family members subject to the expanded “income sprinkling” proposals to claim a capital gains exemption in respect of qualified small business corporation shares and qualified farm property. In addition, the ability to claim a capital gains exemption in respect of shares held by a trust would be eliminated.
The federal government indicated in the October 16th announcement that it would not be moving forward with proposed measures to limit access to the Lifetime Capital Gains Exemption.
Passive Investment Income
The July 18th proposals aim to eliminate the perceived advantages of a corporation investing after-tax small business income. While no draft legislation was released at the time, the potential methods put forward were seen as cumbersome and resulting in highly punitive tax rates. In addition, the proposals failed to recognize that there are many bona fide reasons for businesses to retain and invest after-tax business income.
On October 18th, the federal government announced that it is moving forward with measures to limit the deferral benefits of passive investment income within private corporations with the following clarifications and modifications:
- The measures will only apply on a go-forward basis
- They will apply only to annual passive investment income in excess of $50,000
- Draft legislation is expected to be released as part of the 2018 Federal Budget
On October 20th, the federal government made a further announcement that as it moves forward with the targeted measures on passive investments, it will ensure incentives are maintained for venture capital and angel investors.
Conversion of Income to Capital Gains
The draft legislation that was effective for transactions occurring on or after July 18th was fraught within many “unintended consequences”. Notably, the additional income tax burden to certain estates holding private corporation shares would have been exorbitant (possibly 70 to 90%!), and the tax cost of selling an incorporated business or farm to a family member would have been approximately 20% higher than selling to a third party.
On October 19th, the federal government announced that it would not be moving forward with measures relating to the conversion of income into capital gains.
October 24, 2017 Economic Statement & Future Announcements
It was also announced on October 19th that the federal government’s fall Economic Statement will be tabled on October 24, 2017.
As further information and draft legislation become available, Davis Martindale will continue to provide timely analysis and recommendations to our clients.
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