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Private Corporation Tax Planning Changes

Tax

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Avail CPA | Tax News August 2017

The federal government has released its proposed changes to the Income Tax Legislation as it relates to tax planning for private corporations. A summary of the Department of Finance’s proposal is below.

Income Splitting

To apply for taxation years after 2017 with a transitional period for 2018

1 – Extension of the Tax on Split Income (TOSI) rules – often referred to as Kiddie Tax rules. TOSI results in dividend income or shareholder benefits issued to a minor child to be taxed at the highest marginal rate.

  • Specified individuals caught under these rules will no longer be limited to minor children but where amount is considered unreasonable will include related adults as well such as spouses, adult children as well an extended definition to include aunts, uncles, nieces and nephews.
  • A reasonableness test will be introduced to determine the amounts, considering labour and capital contributions scaled for certain age categories
  • There will be added a connected individual test to increase clarification on who is considered a specified individual
  • Split income under this provision will be expanded to include additional types of income such as interest on debt obligations and gains on distribution of property.
  • LCGE will no longer be available to minors
  • Gains accrued while property is held by a trust will no longer be eligible for the LCGE (there will be some transitional rules here)
  • If the gain falls under the TOSI rules above, it will not be eligible for the LCGE
  • Tax reporting requirements for trusts will be amended to be more similar to partnerships and corporations
  • T5 slips will be required for interest paid to individuals out of partnerships and trusts (similar to that already in place for corporations)

2 – Constraining multiplication of Claims to Lifetime Capital Gains Exemption (LCGE) - The target of this change is for family trusts that have been used to multiply eligibility of LCGE used on as sale of business

3 – Improvement on the integrity of the tax system

Passive Investments inside a Private Corporation

Intended to apply on a go forward basis but will be drafted with the intention to limit impact on existing passive investments in a corporation

The government does not want private corporations to be used as personal savings vehicle, such as a TFSA or RRSP, as there is no limit to the tax deferral within a corporation whereas the TFSA and RRSP have regulated limits. In the past when refundable tax was brought into the tax regime there was a second component that was intended to compliment it: a tax on non-active assets to ensure private corporations were not used as a tax deferral vehicle. This second piece was removed from legislation due to complexity at the time, but the Department of Finance’s position is that these two components were designed to work together.

The proposed changes will not impose a tax when non-active assets are purchased and will instead amend the tax on investment income to be non-refundable and at a rate equal to the highest personal tax bracket. They also propose to change the legislation on dividends from that income with the intention for people to be in the same net worth position whether they earn the investment income personally or in a corporation. This new approach will require tracking on how passive income is derived to determine how it will be taxed at the individual level. Two methods for tracking this were considered:

1 – Apportionment Method

  • Three pools will be tracked to determine where the funds for the investments were derived: income subject to the small business rate, income subject to the general rate, and shareholder contributions. The passive income will then be apportioned based on these pools.
  • The corporation can elect to have all dividends paid as eligible dividends – the downside being that they will no longer have any access to the small business deduction.
  • The corporation can elect to have all dividends as non-eligible which would eliminate the need to track the pools above.
  • The corporation could elect to have all income treated as passive income – the income would be taxed at the highest personal tax rates in the corporation. This would more likely be eligible if there is high paid up capital or shareholder contributions to the corporation.

2 – Elective Method

The government also proposes that the non-taxable portion of the capital gain in the corporation will no longer be added to the capital dividend account (CDA).

Converting Income into Capital Gains

Effective for transactions on or after July 18, 2017

These changes are in response to cases lost when seeking to apply 84.1 or General Anti-Avoidance Rule (GAAR) when a transaction that would have otherwise been a dividend is converted to a capital gain. The government realizes that this current legislation causes restriction on legitimate intergenerational transfers of businesses. Current amendments proposed are as follows:

1 – Amendment to 84.1

  • To ensure the section prevents individuals from using non-arm’s length transactions to step up the cost base of shares of a corporation in order to avoid 84.1 in a subsequent transaction
  • This rule will apply to transactions where an individual shareholder received non-share consideration such as cash from a private corporation, that amount would be treated as a taxable dividend. The intention will be to preserve the concept of integration so that income taxed in a corporation cannot be paid to shareholders as a capital gain.

2 – Implement an anti-surplus stripping rule to non-arm’s length transactions This rule will apply to transactions where an individual shareholder received non-share consideration such as cash from a private corporation, that amount would be treated as a taxable dividend. The intention will be to preserve the concept of integration so that income taxed in a corporation cannot be paid to shareholders as a capital gain.

To discuss how these proposed changes may affect your business, contact your Avail CPA accountant today. 

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