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Government Tax Proposals on Tax Planning Using Private Corporations are Extremely Far Reaching!

Back Ground

On July 18, 2017, the federal Finance Minister issued a consultation paper, draft legislation and explanatory notes on proposed changes to the taxation of private corporations and their shareholders. Presumably, the proposals are meant to further the government's initiatives to tax the rich, provide tax fairness to all taxpayers and assist the middle class. The proposals in my view do not achieve these objectives, the proposals can apply to almost every private corporation and their shareholders and could most adversely affect the middle class. Some of the proposals are not set to take effect until 2018, and some proposals will take effect retroactively on July 18, 2017, if they are enacted. The government has asked the public for feedback up until October 2, 2017, which does not leave a lot of time to respond to the government.

If you are a business owner what can you do?

If you or your family members own a private corporation I would highly recommend that you contact your tax advisor as soon as possible and well before the end of the calendar year 2017 to see if there are planning opportunities available that you can take advantage of before the end of the year and assess the impact that the changes will have on a go-forward basis. 

Please contact us if you would like to discuss these matters, an initial consultation is always free, and we would be pleased to assist you with this process. 

Proposed Changes

The proposed changes are highly complicated. We have therefore not explained the proposed changes in great detail but have highlighted some of the main issues in very general terms. The proposals are aimed at four specific issues:

  1. Income Splitting
  2. Taxation of Investment Income
  3. Limiting the Life Time Capital Gains Exemption and
  4. Corporate Surplus Stripping.

Income Splitting

In general income splitting is achieved when an individual in a higher income tax bracket reduces their income by having other individual(s) (usually family member(s)) in a lower income tax bracket, pay tax on a portion of the income. The result is that the overall income tax paid is reduced.

There are currently numerous measures already contained in the Income Tax Act (Canada) that restrict the ability to income split unless certain conditions are met. In this regard, one of the rules is that individuals who are less than 18 years of age at the end of the calendar year are taxed at the highest personal tax rate on a dividend received from a private corporation whether the individual owns shares directly or indirectly through a family trust or partnership.

The government proposes to expand this rule to all related individuals who receive a dividend from a private corporation not just to persons under the age of 18. If the proposed rules are enacted, they will apply to the 2018 and future taxation years. There are different sets of rules proposed for persons aged 18 to 24 and for those who are 25 years of age and older. They propose that reasonability tests be applied, which will involve a very difficult analysis of the facts and circumstances going back to years in which the individual became a shareholder directly or indirectly, not just for the 2018 and future taxation years.

Taxation of Investment Income

The proposals plan to tax investment income inside of a private corporation significantly different from the current rules for the 2018 and subsequent taxation years. The rules are overly complicated and are beyond the scope of this blog to expand upon further.

Limitation to the Life Time Capital Gains Exemption (“LCGE”)

The LCGE is generally available to be claimed by the owners of shares that meet the requirements for “qualified small business corporation shares.” By claiming the LCGE, an owner of shares may reduce the overall capital gains tax payable on the disposition of “qualified small business corporation shares” to the full extent of the available LCGE during the year in which the disposition occurs. In 2017, the LCGE limit is $835,714.

The proposals will apply an age limit in determining LCGE eligibility. Individuals would no longer qualify for the LCGE in respect of capital gains that accrued before the taxation year in which they attain the age of 18. A “reasonableness” test would be introduced that would be applied to determine whether the LCGE may be claimed by an individual in respect of a realized capital gain. The proposals would no longer permit individuals to claim the LCGE in respect of capital gains that accrue during a period in which a trust holds the shares.

The measures are proposed to apply to the disposition of shares occurring in 2018 and subsequent years. They have proposed a special election for shareholders to make for their 2018 taxation years to crystallize their available LCGEs which comes with additional complexities. You may, therefore, want to consider to implement planning before 2018 to crystalize the LCGE as well as look at reorganizing the share ownership of your company before 2018.

Corporate Surplus Stripping

The proposed rules plan to significantly impact what is referred to as corporate surplus stripping. This means transactions that have been undertaken to remove corporate assets at capital gains tax rates instead of dividend tax rates from private corporations. Dividend tax rates are generally much higher than capital gains tax rates. The proposals, if enacted will apply retroactively to July 18, 2017. Extreme care needs to be taken if you are considering any type of share transaction involving a private corporation, significant adverse income tax consequences could result.

Letter to our Parry Sound MP Concerning July 2017 ...

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Affiliations

To ensure the best possible service to our clients, we work continually to retain a professional edge by maintaining active memberships in various trade and community associations and being up to date on the latest accounting and bookkeeping software.

Chartered Professional Accountant     ctf    Parry Sound Chamber of Commerce    Parry Sound Down Town Business Association