On July 18, 2017 the Government introduced proposed amendments to the Income Tax Act (Canada) (the “Act”) that will have a profound impact upon the taxation of private corporations and their shareholders. We previously summarized these proposals in our Proposed Changes to the Taxation of Private Corporations and Shareholders newsletter of September 7, 2017.
The public consultation period ended on October 2, 2017. The Minister of Finance, the Honourable Bill Morneau, announced several revisions to the proposals during the week of October 16 to 20, 2017:
- The Government will not be moving forward with measures relating to the conversion of income into capital gains, which would have had a profound impact on intergenerational business transfers and other transactions involving the reorganization of the ownership of shares of corporations;
- The Government will not be moving forward with measures intended to limit access to the Lifetime Capital Gains Exemption for shares of “qualified small business corporations”;
- The small business rate will be reduced by 0.5% effective January 1, 2018, and by another 1% effective January 1, 2019. These adjustments will be accompanied by an increase in the marginal tax rates on non-eligible dividends to preserve the integration of tax rates on income earned by a corporation that is distributed to shareholders as a dividend;
- The Government will simplify the proposed “Tax on Split Income” rules with the aim of providing greater certainty for family members that contribute to a family business. Although no details were provided, the Government stated that it will “reduce the compliance burden with respect to establishing the contributions of spouses and family members including labour, capital, risk and past contributions, better target the proposed rules, and address double taxation concerns”; and
- The Government will move forward with measures to limit the deferral benefits available to private corporations investing after-tax active business income in passive investments. The Government stated that the measures will ensure that existing passive investments held by private corporations are not affected by these changes, and indicated that future investments generating income below a new $50,000 passive income threshold will also be exempted from the changes. The details of these measures are to be released with the 2018 Federal Budget (likely to be in March 2018).
Unfortunately the Government has not yet released any amendments to the proposed legislation. Accordingly, the exact nature of the changes described above, and the implications for private corporations and their shareholders, cannot be precisely determined at this time.
Tax on Split Income
As noted above, the Government intends to proceed with implementing changes to the Act that will restrict the ability of taxpayers to split income via private corporations. The Act already includes various measures intended to limit the scope of income splitting, including the existing Tax on Split Income (“TOSI”) regime (often referred to as the “Kiddie Tax”).
The TOSI currently applies tax at the top marginal rate on certain types of income (including taxable dividends from private corporations) received by minors under the age of 18, and limits the deductions and credits that can be claimed to reduce tax payable on such income. The result of this is to eliminate the benefit of the low marginal tax rates and basic personal credits that an individual would otherwise use to reduce or eliminate the personal income tax payable on dividends or other income from a private corporation.
The proposed amendments target income splitting through a significant expansion of the TOSI rules that will apply for taxation years beginning after 2017.
Under the proposed amendments, any individual receiving property income (e.g. dividends, interest, etc.) from a private corporation could be subject to the TOSI in 2018 and later years. An exemption from the new TOSI is provided for income that does not exceed what would have been paid to an arm’s-length party having regard to:
- Any functions relating to the source business performed by the individual, to the extent that the income recipient is engaged in the activities of the business (e.g. a reasonable return on labour). However, if more than 50% of the revenues of the source business are derived from property income (e.g. income from rental properties, interest income, etc.), any labour or other functions performed by the individual will be ignored.
- The assets contributed, directly or indirectly, by the income recipient in support of the source business (e.g. a reasonable return on capital invested). However, if the income recipient received financial assistance (a term not defined in the draft legislation) directly or indirectly from a related person when making a capital contribution to the business, that capital contribution will be ignored.
- The risks assumed by the individual in respect of the source business, and
- All amounts paid to the individual (i.e. dividends, interest, salary, etc.) in the past in respect of the source business.
Additional restrictions apply where the income recipient is under the age of 24. Most notably, an individual’s labour or other functions will be ignored unless the individual was actively engaged on a regular, continuous, and substantial basis in the activities of the business. This may be one of the areas that are “simplified” before the TOSI is enacted, but no specific announcements have been made.
The proposed TOSI amendments could have a significant impact on dividend (and other compensation) planning beginning in 2018 and future taxation years. If you feel that the new TOSI rules might apply to shareholders or other recipients of income from your private corporation in 2018, you should consider paying dividends in 2017 while the existing rules are still in effect.
2017 Dividend Planning
There are a number of reasons to consider increasing the amount of dividends to be paid from a private corporation in 2017:
- The small business tax rate is being reduced in 2018 and 2019, and these reductions are accompanied by an increase in the marginal tax rate on ordinary dividends. If your private corporation has a substantial balance of retained earnings taxed at past (higher) small business rates, the extraction of these retained earnings in future years subject to the new ordinary dividend tax rates could result in a higher combined corporate and personal tax bill.
- The B.C. top marginal personal income tax rate is being increased by 2.1% on January 1, 2018. This will apply to income in excess of $150,000 per annum for 2018 and later years.
- If you feel that the new TOSI, applicable in 2018 and later years, may apply to you or your family members, it may be worthwhile to pay more dividends in 2017 to take full advantage of the marginal rates still available to you and your family.
If you would like our assistance on this matter, please complete the attached 2017 Dividend Tax Planning Schedule and return it to your D&H Group LLP advisor as soon as possible. We can then assist you in evaluating the appropriate amount of dividends to be declared and paid or payable before the end of 2017.
For illustrative purposes, we have summarized the estimated level of income taxes payable in 2017 on the receipt of various amounts of ordinary dividends and of eligible dividends by an individual with no other sources of income for the 2017 taxation year, and the estimated income taxes that would be payable if the dividends were subject to the TOSI if paid in the 2018 or later years.
Because the TOSI denies an individual the benefit of basic personal credits and low marginal tax rates, the personal income tax on a dividend paid in 2017 (when TOSI is not yet applicable) is much lower than the personal income tax paid in 2018 (if TOSI applies).
|Estimated Tax – Ordinary Dividends
|Estimated Tax – Eligible Dividends
|Actual amount of dividends
|Subject to TOSI
|Subject to TOSI
Download a 2017 Dividend Tax Planning Schedule.